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.”

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