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Dell warning points to uncertainty in PC market

The recent spate of earnings warnings, combined with lackluster results from Compaq, raises concerns about the health of the PC industry.

Like Gateway and IBM before it, Dell Computer is telling investors that the most recent quarter wasn't as good as expected because of component shortages and Y2K concerns. But the results may hint at a more ominous trend: a possible slowdown in the PC industry.

After extraordinary sales in 1998 and 1999 in both the corporate and consumer markets, leading computer makers are reporting declining revenues. The results are prompting analysts to ask whether the world has, for the moment, had its fill of personal computers.

While it is too early to say for sure, the recent spate of earnings surprises, combined with Tuesday's lackluster results from Compaq, raise concerns about the segment's health.

Dell today blamed a shortage of high-end Intel processors for slowing sales, but some analysts are not convinced. (See related story)

"The component shortage is overblown. Dell is a pure-play leading indicator of the commercial PC market," said Ashok Kumar, an analyst at US Bancorp Piper Jaffray, who theorized that corporate customers may have started to put the brakes on purchasing following the Y2K buildup last fall.

"There are more questions than answers," Kumar said. "There are no definite answers, but there is some disconnect going on."

To some degree, PC makers may be victims of their own success. Anything but outstanding growth seems to lead to disappointment.

For instance, market research firm Dataquest earlier this week predicted that PC shipments may increase by 17 percent in 2000. That sounds good, until compared to 1999's growth rate of nearly 22 percent.

In addition, plunging PC prices--declining at a clip of 15 percent annually--make it hard for companies to maintain high profit margins, according to Kumar and others. To succeed, companies have to grow two to three times as fast as the overall market to maintain historical earnings trajectories, he said.

One statement that analysts latched onto during a conference call with Dell today was the warning from chief financial officer Tom Meredith that the company may see revenue growth of only 30 percent this year.

Such a clip would be high for most industries, but Dell has enjoyed higher growth rates in the past, said Roger Kay, an analyst with International Data Corp.

A slide in Dell's stock could be one effect, Kay speculated. Dell currently holds a price-earnings ratio of around 69. Other PC companies have P/E ratios in the low 40s. "The problem with Dell is that the expectation is high and built into the P/E ratio," he said. "If they make a bobble, the implication is that you can slash the stock in half."

Charles Smulders, an analyst for Dataquest, said in a prepared statement earlier this week that PC companies must innovate to spur sales.

"Much will depend on the industry's success in convincing

x
their customers to replace PCs more frequently," he wrote. "Key factors will be the industry's ability to bring smaller, less complex, cheaper products to the business market and industrially designed products to the home."

PC makers, however, are not the only ones to blame for a sales slowdown--some of the cause lies with key suppliers.

Intel, for instance, delayed products and then could not manufacture enough of them to keep up with demand. Gateway blamed its shortfall on an inability to get enough 400-MHz and 450-MHz processors.

Dell complained today about not being able to get enough of Intel's fast "Coppermine" Pentium IIIs. These chips, originally due in September, didn't arrive until late October, and in limited quantities.

The Round Rock, Texas, company, which prides itself on being able to deliver computers within seven days, could not ship some Coppermine systems for up to 30 days, according to sources.

Another problem was the unavailability of advanced memory technology from Rambus. Dell planned to release a number of Rambus-based systems, said Kay, more than other manufacturers. But difficulty in getting Rambus-based memory crimped sales, said several sources, forcing the company to go out and buy standard computer memory at essentially the last minute. Toward the end of the year, Dell also said rising prices on standard memory would affect year-end sales.

Pessimism about the PC industry has proved wrong before. In 1998, several analysts predicted a slide in sales because of an oversupply of computers in the first half of the year. Sales for the year, however, exceeded expectations and led to high profits for Dell and others.

In fact, early sales predictions for both 1998 and 1999 proved low.

Dell's warning, which was issued after the 1 p.m. PST close of regular trading, sent its shares down about $4 to $36.38 in after-hours trading.

The shares of other computer makers also dipped in after-hours trading on the news.

Shares in Micron Electronics slipped about 31 cents to $10.88, Apple was down $2.19 to $108, Gateway shed $2.25 to $59.00 and Compaq lost 50 cents to $28.88. Shares in IBM and Hewlett-Packard were unchanged.

Despite today's setback, Dell executives said that after a slow first quarter, which will go from February to April 2000, business will get back on track.

Meredith, along with CEO Michael Dell, predicted that sales to corporate customers would rise proportionally as large companies embrace Internet businesses and undertake major upgrades.

Meredith cited a recent market research study indicating that 63 percent of chief information officers at large companies call e-commerce their most pressing goal.

"We're entering a period where businesses will have to build infrastructure to create online businesses," Meredith said, asserting that the factors that dragged down fourth-quarter earnings, namely component shortages and underwhelming corporate sales because of Year 2000 issues, were not likely to be repeated throughout 2000.

"We don't see either of those factors being consistent throughout the year," Meredith said. "We clearly are trying to calibrate (Wall Street) expectations, and allow ourselves more leeway to manage through turbulent times."

Michael Dell echoed the sentiment that the poor quarterly performance was an aberration.

"Our business is one where you win or lose in the transitions. This one was quite challenging because of the environment we found ourselves in. But we don't plan to fail."

At least one analyst agreed: "I think everyone will look past this quarter," said Lou Mazzuchelli, financial analyst with Gerard Klauer Mattison. "It's important to look at the outlook going forward, and I think it will be favorable."