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PC Buying: It's Business' Turn

By Megan Graham-Hackett Demand for personal computers has recovered following a two-year slump. Largely led by consumer and notebook demand, 2003 marked the first double-digit rise in PCs shipped since 2000, and Standard & Poor's Equity Research Services believes the industry could achieve double-digit unit growth again in 2004.

The sector's downturn began in 2001, when PC shipments fell 3.9%, according to market researcher IDC. This was followed by marginal growth of just 1.5% in 2002. S&P projects 9% to 11% unit growth for 2004, following an 11% jump in 2003.

TIME TO UPGRADE? However, two important factors could influence this estimate. We have projected only a gradual increase in corporate buying, a customer base that has shown little PC demand in the past few years. Indeed, corporations, enjoying the benefits of an improving U.S. economy, could begin to upgrade their PCs in a meaningful way by the end of 2004.

Comparisons will be more difficult in 2004 as growth rates in 2003 came off a two-year slump. Most market researchers expect that consumer buying, which has led PC demand for the past two years, will not be as strong in 2004, so the bulk of the growth forecast for 2004's second half is expected to come from the corporate sector.

S&P economists project that real gross domestic product growth will accelerate to 4.6% in 2004, from an estimated 3% rate in 2003. We now forecast project that worldwide PC unit sales in 2004 could rise from 9.5% to 11% in this environment. The figure is expected to hover in the 7%- to 12%-a-year range from 2005 through 2008.

GLOBAL GAINS. In the fourth quarter of 2003, U.S. PC sales continued to be boosted by strong consumer demand as computer users, lured by compelling prices on notebooks, migrated to them from desktops. IDC estimates U.S. PC shipments rose 11.4%, down from the 16.1% rate of the third quarter, but still quite healthy. However, while heavy holiday promotions spurred unit demand, the resulting revenue continued to be lackluster. Despite some signs of recovery in the corporate market, we don't expect industry momentum to accelerate meaningfully until the second half of 2004.

Because the U.S. accounts for 35% to 40% of global unit PC demand, American growth is important in supporting our global growth forecast for 2004. For Europe, Middle East, and Africa (EMEA), IDC reported an 18.8% year-to-year increase in PC shipments for the fourth quarter of 2003, a similar pace to that of the third quarter.

Again, heavy promotions spurred demand and led to notebook unit growth of 40% in the quarter, on a year-over-year basis. We expect EMEA demand to contribute to global unit gains in 2004. However, while we forecast continued strong notebook demand for the region, we believe the pace could be somewhat lower than in 2003.

HP ON TOP. The top PC vendors -- Dell (DELL

, recent price: $33.65), Hewlett-Packard (HPQ

, $23), and IBM (IBM

, $93) -- all experienced strong, double-digit year-over-year unit gains in the fourth quarter, according to IDC. HP edged out Dell for the No. 1 spot in the global PC market in the quarter, as its unit growth surged 21.4%. We believe this partly reflected the outfit's strong presence in Europe and the 25.6% unit growth it recorded in the EMEA region. In addition, HP has a greater percentage of its PC sales from consumers (vs. peers such as Dell and IBM) and hence benefited from their strong buying during the holidays.

HP's U.S. market share widened to 21.7%, from 21.1% a year earlier, according to IDC, placing it in the No. 2 spot. Dell remained the domestic market leader by a wide margin, despite posting unit growth that was below HP's. In the fourth quarter of 2003, Dell garnered 30.2% of the U.S. PC market, as unit sales grew 16.8%. In the global market, Dell fell to the No. 2 spot, with 16.3% market share, as units shipped grew 19.7% in the fourth quarter -- marginally below HP.

We believe Dell could regain the top spot if the corporate market for PCs recovers. Dell is a leading supplier to corporations, and we believe it's the price leader in that market. As a direct seller, it benefits from passing lower component costs through to customers faster than its rivals, so it can lead the competition in price cuts.

A NEW NO. 3? Dell has leveraged its position as the low-cost producer to make impressive gains in market share. However, we note that this advantage is somewhat compromised when component prices are rising. This issue is important to watch as 2004 unfolds.

IBM was the third-largest vendor in the worldwide PC market in the fourth quarter, with 6% market share, up slightly from 5.9% in the year-ago period. IBM's global PC shipments rose 17.7%, above the 15.2% rate for the overall market. It remained No. 3 in America, ahead of eMachines and Gateway (GTW

, $5.28) (which merged in March, 2004, so the combined new company could unseat IBM for the No. 3 spot in the U.S.).

IBM's U.S. PC unit shipments rose 19.6% in the fourth quarter, according to IDC. This was ahead of Dell and HP and pushed its market share to 5.4%, from 5.2%. We view this as an accomplishment as IBM exited the U.S. retail PC distribution network in October, 1999, and now sells its consumer Aptiva line only via the Web. IBM had previously sold this line through more than 70 U.S. retailers, including major chains such as Best Buy, Circuit City Stores, and OfficeMax.

IBM'S EDGE. While we now have accumulate or buy recommendations on the three leading computer makers, the rationales vary. For Dell, our accumulate recommendation reflects our opinion that as the low-cost provider, it should continue to garner share (albeit at a slower pace than in the past two years). Our 12-month target price of $39 is based on our discounted-cash-flow (DCF) analysis, which uses free-cash-flow growth of 10% over the next 15 years and a weighted average cost of capital (WACC) of 10.7%.

For HP, ranked accumulate, we also think it should benefit from an upturn information-technology spending, expected in the second half of 2004. Along with its large installed base, we believe that HP has improved its cost structure vs. Dell over the past year and can more effectively compete on price. This change in its business model should enable HP to deliver more consistent results and could narrow the discount its shares trade at relative to peers on a price-to-sales basis. Our 12-month target price of $27 is based our DCF analysis, which applies 7% free-cash-flow growth over the next 15 years and a WACC of 10.4%.

Finally, our buy recommendation on IBM shares largely reflects our view of its competitive standing vs. peers in enterprise computing and our assessment of a compelling valuation. We believe IBM's assets in software and services will prove to be important competitive advantages as IT customers look to simplify and automate their computing environments, making them more responsive, manageable, and easily monitored. Our 12-month target price on the shares is $121, based on our DCF analysis, which includes our assumption of free-cash-flow growth over the next 15 years of 7.8% and a WACC of 10.34%.

Note: Megan Graham-Hackett has no stock ownership or financial interest in any of the companies in her coverage area. She's a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion. Analyst Graham-Hackett follows computer hardware stocks for Standard & Poor's Equity Research Services

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