PC Industry Ready for an Upswing?

Noting that the PC market is showing signs of maturity after 20 straight years of growth, Deutsche Banc Alex. Brown initiated
coverage of the PC industry Wednesday, giving buy ratings to Dell, Compaq and Gateway, and a market perform rating to Apple

DB Analyst George Elling gave Dell the top slot, saying it is currently the best-positioned PC company and is also better positioned
over the longer-term. However, he noted that Compaq, if it can complete its merger with Hewlett-Packard, might have what it takes to
become a more complete offering.

“As in the past, we believe there will be significant consolidation in the industry and probably none of the vendors of today will
look the same five years down the road,” Elling said. “Dell’s direct model appears to give it an edge from a standpoint of holding
onto market share, although its lack of R&D may curb its ability to pioneer future market opportunities. Compaq, on the other hand,
realized several years ago that the PC industry would not be a market that would grow forever and thus sought out to acquire
companies to expand it’s ability to penetrate the enterprise and service operations. In our view, Compaq combined with HP, when
completed, could be well positioned as a turnaround play.”

Of course, that assumes that the merger will go through, a point that was brought into question when the family of HP co-founder
William Hewlett voiced its opposition to the
merger Tuesday. Hewlett’s family only controls about 5 percent of the company’s stock, but it is considered highly influential among
HP shareholders.

As for Gateway and Apple, Elling said their futures are both still in question.

“The jury is still out on the sustainability of Gateway and Apple as standalone PC companies, although both companies are subtly
evolving their business models in new directions,” he said.

In any case, Elling said that PC stocks could be enticing picks despite poor near-term fundamentals, a reduced outlook and low
visibility. In fact, he predicted the market is approaching a bottom.

“We believe the industry is at or near a cyclical trough in unit shipments and profitability,” he said. “Checks indicate U.S. demand
has recovered following the September 11th tragedy, with improving visibility on a modest seasonal up tick in the fourth quarter.
Replacement sales now account for an estimated 60 percent to 70 percent of all unit shipments, expected to reach 80 percent to 90
percent by 2005, providing somewhat of a cushion for the industry. At the margin, we believe the recent release of Windows XP and
the possibility of a stronger corporate replacement cycle represent potential demand catalysts in 2002.”

Despite a slower uptake for Windows XP than was recorded at the release of Windows 98, StatMarket said Wednesday that Windows XP’s global usage share rose to 2.36 percent by
Nov. 5, 12 days after it hit retailers’ shelves.

“If the past is any indication, Windows XP will be the dominant OS on the Web by this time next year,” said Geoff Johnston, vice
president of product marketing for StatMarket.

Elling also voiced his opinion that the market already reflects most of the industry’s and individual companies’ bad news, and that
the biggest risk to owning shares in the industry is the timing of the economic recovery.

“The increasingly cyclical nature of the PC sector warrants a more value-driven approach to investing in the space, in our view,” he
said. “Accordingly, we believe that absolute and relative P/E valuations have little relevance in the current depressed earnings
environment. More traditional “value metrics” such as EV/sales, EV/EBITDA and price/book are currently well below historical
averages for select names in our coverage universe. Dell is the clear leader in terms of positioning for both a cyclical upturn and
the longer-term secular growth in servers and storage. On a valuation basis, we believe Compaq and Gateway offer attractive upside
potential. We are more cautious on Apple’s positioning and valuation.”

News Around the Web