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Computer Manufacturers Positioned for Rebound?

Computer manufacturers were hit early and hard by the deteriorating economy, but that may soon turn around and those companies that have positioned themselves correctly during the downturn stand to make big gains when the market is revitalized, according to research by Goldman Sachs & Co.

U.S. market leader Dell Computer Corp. stands to come out the big winner, according to GS analyst Joe Moore.

"Despite difficult sector fundamentals near term, we believe that Dell's market share gains are reaccelerating given recent component price declines, and the Dell's structural position is improving across all of its end markets," Moore said in research Wednesday.

Moore added Dell to GS' Recommended List, with a $32 12-month price target. He cited five key factors that will drive Dell's success:

  • Dell's cost advantage improves dramatically during periods of industry weakness;
  • Weak business conditions continue to put downward pressure on competitors;
  • Advantages of the direct model are spreading to mid-range servers and low-end storage;
  • Putting pressure on servers should indirectly create a better price environment in desktops;
  • Fears of an extended price war are overblown.

That is not to say that other manufacturers will be left in the dust.

Moore came out bullish on Apple Computer Inc. , a company that is beginning to epitomize the Phoenix of the digital age. Dell last year managed to wrest control of the educational sales market from Apple and missteps with the Cube and failure to bundle DVD technology with its iMac computer further hurt Apple's market share. But Moore said things are looking up for Apple.

"We think Apple should outperform its sector over the next few quarters with a very strong product lineup of both hardware and software, with continued strength in the titanium PowerMac, and bundling of the new operating system sooner than expected," he said. "In the intermediate term, the company has continued to execute on the new product front, recovering from the Cube debacle with back to back successes in the two notebook lines and a strong debut for OS X. The company recovered quickly from the problems of last Christmas, without any headcount reductions, and there is substantial room for operating leverage with a strong balance sheet. The stock has moved up substantially, reflecting much of this news, but we do expect the momentum to continue and the potential for upside from operating leverage is significant."

On the longer-term front, Moore said Apple needs to focus on growing its market share by expanding its user base beyond the Mac faithful. He said the company has put together a solid plan for achieving that, which includes a strong product line, a vision for the Mac platform, and the Apple retail store concept.

GS has given Apple a market outperformer rating.

Unsurprisingly, GS also gave world sales leader Compaq Computer Corp. a market outperformer rating.

"The valuation of the stock is at a multi-year low on a price-to-sales basis, and earnings are likely to recover in an economic recovery scenario next year," Moore said. "The company does face significant strategic challenges in focusing on growing the enterprise and services businesses while harvesting the commodity businesses (primarily the PC business) in a tough macroeconomic environment, but the valuation should limit downside potential with material upside leverage when the environment improves."

Moore said Compaq has positioned itself for gains in a number of business segments, including external storage, high-end four-processor and eight-processor industry standard servers, the professional services business and segments of the Access business (such as the iPaq handheld).

"The Capellas-led management team has substantially increased the development resources in all of these differentiated areas, and while there are currently business challenges everywhere, we are comfortable with the strategies that are in place for these divisions," Moore said.

However, he also noted that its desktop and notebook PCs, as well as its low-end one- and two-processor industry standard servers, are coming under significant pricing pressure. In the short term, he said, Compaq may find that volatility in those areas may offset gains in the proprietary areas.

Gateway Inc. also made the short list. Moore gave Gateway a market outperformer rating.

"While revenue visibility is likely to remain a bit cloudy in the near-term given the combination of weak consumer demand and a change in the channel strategy, recent actions will serve to revitalize the Gateway brand and will position the company to leverage its direct cost structure and unique control over the point-of-sale," Moore said.

He noted that before January, Gateway's strategy diluted the company's relationships with its customers through a combination of off-brand advertising, a channel strategy that didn't fully leverage the benefits of the model, a heightened focus on beyond-the-box services that led to neglect of the box itself, and a lack of focus on high-end PCs.

"The initial focus is to restore the characteristics of the brand, including cutting off inappropriate channels that diluted Gateway's relationship with the customer," Moore said. "This may cause some initial dislocation in sales, but management has already seen improvements in key customer satisfaction areas. We expect management to be successful in this turnaround effort, resulting in restored profitability and sales growth next year."