Computer Hardware: Wait 'Til Next Year


By Megan Graham-Hackett Computer hardware companies -- the makers of PCs and servers -- had a rough 2001. Shipments of PCs declined for the first time in 16 years, posting a hefty drop of 12.4%. And worldwide factory revenues for servers fell 19%, to $49.8 billion. The main culprit was the global economic slowdown.

How do the industry's prospects appear now? The outlook for PC sales growth in 2002 remains uninspiring. And given the uncertainty surrounding corporate information-technology (IT) spending plans in 2002, the outlook for server demand remains somewhat murky. But the picture for both segments appears brighter for 2003.

In 2001, PC sales inevitably suffered when compared with the heady increases posted from 1997 to 2000, as the surge in investment in these machines made further growth of this base difficult. Typically, industry sales grow at an annual rate around 15% -- and yet growth stretched well above that level for several years.

XP ACCELERATION. As for 2002, market-research outfit International Data Corp. (IDC) forecasts growth of 3% in unit shipments worldwide. This was raised from IDC's previous forecast of 1.8% due to better-than-expected retail sales in the U.S. and growing demand in Western Europe. We at Standard & Poor's currently project unit growth of 3.9%.

Better growth should come in 2003, however. One key factor in this prospective uptick in demand is that PCs purchased as replacements ahead of the Y2K problem are now entering the third year of their lives, meaning many users are probably ready for an upgrade.

And Microsoft's Windows XP could provide a compelling incentive for consumers to improve their current PCs to take advantage of the new operating system. Given the system requirements for Windows XP, coupled with the attractive prices of PCs in this intensely competitive environment, many consumers will likely buy a whole new computer instead of just the new operating system.

GLOBAL UPTURN. Another key to growth in PC demand will likely be the timing and the strength of the upturn in the U.S. economy. S&P economists believe that the rebound began in early 2002, stimulated by fiscal and monetary policies. The long-term U.S. economic outlook remains favorable and should support ongoing corporate investment in IT as well as consumer spending on PCs.

During the year, IDC predicts that U.S. PC shipments will rise 2.7%, with the recovery in demand coming from strength in consumer purchases. Although most commercial segments should improve, IDC expects overall U.S. commercial shipments to decline 1.1% for 2002.

A stronger American economy should support global economic growth, which should aid non-U.S. sales for PC makers. IDC predicts that PC unit growth in some foreign markets will outpace that of the U.S. this year. A slow recovery is anticipated in Western Europe, with shipments rising 1% in 2002. Asia-Pacific will fare better: IDC expects 12% PC unit growth in 2002.

BLADE BOOST. As for servers, IDC believes -- and most computer hardware vendors concur -- that demand in the server market has likely seen the bottom, and some recovery should occur as the U.S. economy improves during 2002. However, S&P forecasts that the industry won't see a significant improvement in demand until 2002's fourth quarter at the earliest, with an upturn more likely in 2003. IDC projects 6% server revenue growth in 2003, which S&P believes is a reasonable estimate.

One recent technology advance could provide the server segment with a new growth engine: the blade server, a single motherboard containing the CPU, memory, networking, and associated electronics. The typical configuration for blade servers is to stack them in a rack-mounted platform (or chassis) where they share hard drives, cabling, power supplies, cooling fans, and other equipment. This density is one reason for the blade server's popularity. The savings in floor space and electric power are believed to be substantial.

Blade servers are initially expected to replace the popular rack-mounted servers in typical Internet infrastructures, used for applications such as caching, firewall, and load balancing. (Rack-optimized servers accounted for 34% of all servers sold in 2001, according to IDC.) Yet their role is likely to be limited to certain applications.

HARD CHOICES. Hewlett-Packard and Compaq introduced blade servers in January, 2002, while IBM has been marketing them from RLX Technologies. Sun Microsystems introduced its blade server in late February, 2002. Dell is expected to release its own model by midyear, while IBM should unveil its own Excalibur blade servers by late in 2002's third quarter.

Blade sales should accelerate in the next several years. IDC expects the market for Intel-based blade servers to grow from $148 million in 2002 to $2.9 billion in 2006, at which point they're expected to represent 25% of overall entry-level server unit sales and 10% of server sector revenues.

Where does S&P stand on the major players in hardware? Our top picks are IBM (IBM) and Sun Microsystems (SUNW), both ranked 4 STARS, or accumulate. We have 3-STARS (hold) rankings on Dell Computer (DELL) and Hewlett-Packard (HPQ), which recently merged with Compaq. Analyst Graham-Hackett follows computer hardware stocks for Standard & Poor's


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