The Winner of the PC Price Wars: Dell


By David Shook Amid the high-tech carnage on Wall Street this year, you can think of PC makers as the wounded warriors in a forgotten battle. Sales growth should climb 15% this year in the computer industry. But that's half the pace manufacturers enjoyed a few years ago. What's worse, a price war has erupted that's chipping away at every PC maker's profits.

Many people are writing off any chance that the industry can recover the growth it had during the go-go years of '90s, but there's still plenty to like about one PC giant: Dell Computer (DELL). The Round Rock (Tex.) computermaker is the first to point out that it's the cause of today's price war. As the newly crowned market-share leader for computer sales, (Dell recently overtook Compaq Computer [CPQ

] in total volume), Michael Dell's company is using aggressive pricing to widen its lead.

So far, the strategy seems to be working. Dell is creating demand for laptops and servers at discounted prices at a time when customers remain hesitant about upgrading. Even as the priced-to-move strategy cuts deep into its own profit margins, Dell has shelter from the storm in its lower cost structure: The company sells only directly to consumers, not in stores.

BATTLEFIELD ENDURANCE. And because it believes that all computer technology is becoming more standardized, it hasn't invested much on hardware engineering and research. Compaq spent about $350 million in each of the last two quarters, while Dell, which hasn't released first-quarter results yet, spent about one-third that amount in last year's fourth quarter.

These are important factors in deciding which of the PC stocks is the best investment right now. Many analysts believe Dell has an advantage over rivals Compaq and Gateway (GTW) because it can hold out longer in the price war -- even if the economy doesn't rebound soon. "Dell is setting the strategy for a weakened PC industry," says David Bailey of Gerard Klauer Mattison & Co. No question, the price-cutting has other computermakers limping. Gateway, with a stock price of $18, posted a $500 million loss in the first quarter -- its first red ink since 1997.

Compaq lost the title of world's largest computer maker in April -- a ranking it had held since 1994. Then it said first-quarter net income fell 74%, to $78 million. Earnings in the second quarter will fall below expectations, too, Compaq warned recently. Result: The stock promptly dropped 16%, to $17, after the Apr. 25 earnings release, putting Compaq 50% off its one-year high of $35.

GLOBAL GAINS. Compare that with Dell, which has a share price of $26. Yes, its stock has also fallen 50% off the one-year high. And both stocks are priced about the same: Dell's price-to-earnings ratio is 27, making it only slightly more expensive than Compaq's 24 multiple. But Dell's advantage lies in the unit-sales trends. In the first quarter, it moved 4.15 million units, up 30% from last year's levels, according to computer research firm IDC.

Dell's global market share rose to 13.1% from last year's 10.4% in the first quarter. IDC says the company posted 28% growth in the U.S., where it topped all computermakers with a market share of 24% on sales of 2.5 million units. Yes, Dell is having a bad year just like everybody else, but its stock has some room for growth, most analysts agree. The First Call consensus recommendation is to accumulate, and that's higher than for other computermakers.

Meanwhile, Compaq was the runner-up to Dell in both U.S. and global PC revenues. Compaq's global shipments fell about 5%, to 3.8 million units, giving it a global market share of 11.9% percent. Compaq's U.S. sales tumbled 20%, to 1.5 million units, giving it a 14% domestic share, down from 16% last year. "Dell is really pushing ahead trying to take market share in a rocky period," says Stephen Baker, hardware analyst for NPD Intelect. "Dell won't knock Compaq out, but it can hurt second- and third- tier PC makers. The PC industry is still pretty fragmented."

"FOREGO PROFITABILITY." Certainly, Dell has its share of detractors. They say the company's attempts to shed a PC-centric image are just window dressing. Others note that Dell has been slow to expand into storage gear -- where the lion's share of computer hardware investment has gone. And nobody can sustain a price war forever, critics scoff.

Even CEO Dell says there's little reason to assume the industry will see much improvement in the second half. The price cuts on everything from flat-screen monitors to corporate workstations are shrinking the company's profit margins. "Still, the best strategy for us is to forego profitability in margin terms and instead focus on absolute or dollar terms profitability," Dell spokesman T.R. Reid says. "In this environment, we don't give back market share once we've gained it."

In other words, the discounting cuts profits to the bone for smaller competitors who can't afford a long price war, giving Dell a chance to gain even more market share. Analysts are expecting Dell to report 17 cents a share earnings -- down from 19 cents a year ago. With the IDC data showing Dell pulling ahead, the company probably won't disappoint. Shook covers the markets for BusinessWeek Online in New York


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