Computers And Chips

It's hard to imagine that a product selling more than 150 million units a year could be past its prime. But looking at the plunging shares of onetime highfliers like Gateway (GTW), Dell (DELL), and Apple (AAPL), you would think the personal computer industry has one foot in the grave.

So what, exactly, is spooking Wall Street? The simple fact that after years as the bellwether of the technology sector, PC sales growth is slowing. The industry is poised to grow 16.6% in 2001, according to market researcher International Data Corp. That's a great number if you're selling cars. But if you sell PCs, which have seen average growth of more than 20% for nearly a decade, it's like a punch in the face. "The computers people have today are adequate, so that turns them into a discretionary purchase," says Forrester Research analyst Carl Howe.

Even as the PC takes it on the chin, though, the tech industry as a whole isn't necessarily heading for a TKO. Step outside the world of desktop PCs, and you'll find a number of niches, including laptops, that will continue to expand at 20% or better. That's good news for PC makers, since portables offer higher margins than desktops. What's more, consumer devices ranging from Palm-style handhelds to MP3 music players to digital cameras should get a lift as prices come down and features proliferate.

PC makers will share in the success of such devices and the peripherals that enhance them. A year ago, only five manufacturers sold digital music players, for example--none of them mainstream PC makers. Today, more than 50 companies sell them, including industry stalwarts such as Dell Computer Corp., which offers a $300 home digital jukebox, and Compaq Computer Corp. (CPQ), which will set you up with an MP3 player built into its iPaq handheld for $500. Even chipmaking giant Intel Corp. (INTC) is planning a digital music player amid expectations that sales this year will grow 59%, to $1 billion, according to Cahners In-Stat Group. They'll face tough competition, though, from upstarts such as SonicBlue Inc. (SBLU), which sells the market-leading Rio MP3 player for $200.

Handheld computers will also reach a wider audience in 2001, as the likes of Compaq and Hewlett-Packard (HWP) duke it out with Palm (PALM), Casio (CSIOY), and upstart Handspring (HAND). Sales of the devices this year are expected to surge 31%, to 8.7 million units, Cahners says. These devices will grow more powerful and spawn a host of peripherals. Already, thanks to lightweight wireless modems and memory cards, the $149 Handspring Visor can be turned in to an MP3 player, cell phone, or global positioning device--a far cry from the simple task-scheduling machines available little more than a year ago.

It's not just consumer devices that will proliferate over the next 12 months. This should be a decent year for makers of hefty server computers that power the Internet and e-commerce. In spite of the ongoing dot-com havoc, Forrester Research says servers costing from $100,000 to $1 million that run the Unix operating system will see strong growth. Barring a general economic downturn, companies from CitiBank (C) to General Motors Corp. (GM) will likely lay in extra servers to run expanding e-businesses. Forrester expects sales of such machines to surge by nearly a third, pushing revenues in the sector up by 25%. That's good news for Unix leader Sun Microsystems Inc. (SUNW); Chase H&Q believes Sun will see sales growth of nearly 40% and a 43% increase in profits in fiscal 2001, which ends in June. "Demand is just blowing us away," says Sun Vice-President John S. McFarlane.

The hottest growth in servers, though, will be for computers that do only one thing but are designed to do it cheaply and efficiently. Sales of so-called server appliances will nearly double, to $5.2 billion, in 2001, IDC says. These machines perform tasks such as dishing up Web pages, caching often-used pages for quick retrieval, or managing a site's security. Riding that wave will be upstarts such as Network Appliance Inc. (NTAP), which analysts expect to more than double its sales this year.

STORAGE BOOM. Network Appliance is well positioned to catch another wave, too: The boom in sales of devices that store the oceans of data being spawned by the Internet revolution. That trend also spells opportunity for the likes of EMC Corp. (EMC), which Credit Suisse First Boston expects to post profits of $2.3 billion on sales of $12.1 billion in 2001--both up more than a third from last year. The world's data storage leader is almost certain to continue its dominance of this space. But look for a strong challenge from a reinvigorated IBM (IBM), as well as from Hitachi Data Systems, which has shuttered its mainframe business to concentrate on storage.

If these different sectors live up to expectations, the chipmakers who serve the whole tech sector will also have a good year--at least in terms of revenue growth. Market researcher Dataquest Inc. figures semiconductor sales should see a 27.5% increase this year. Profits may be harder to come by. The chip industry's financial results depend on the delicate balance between production capacity and demand. Anticipating strong sales in 2001, manufacturers last year spent billions building new foundries. Maybe they went too far. Analysts now say capacity could exceed demand by mid-2001--some 12 months sooner than many had previously figured. So despite the strong sales, earnings are expected to climb just 11%--a far cry from their 94% growth in 2000, according to the latest consensus estimates from First Call Corp. "You have a malignant pricing environment," says Ashok Kumar, an analyst with U.S. Bancorp Piper Jaffray.

The pain won't be evenly spread. Even as makers of commodity parts suffer, companies selling specialty chips will likely show revenue increases of 30% or better. Both Texas Instruments Inc. (TXN) and Analog Devices Inc. (ADI), for example, make digital signal processors, which manage the torrents of data coursing through everything from cars to televisions. These DSPs should see strong gains as more and more products go digital. Likewise, National Semiconductor Corp. (NSM), STMicroelectronics (STM), and others will continue to profit from a boom in analog chips, which are used in devices such as cell phones to help DSP systems translate analog signals--a caller's voice, for example--into digital blips for transmission over the network. Merrill Lynch figures communications chipmakers Broadcom (BRCM) and PMC-Sierra (PMCS) should see 66% and 86% revenue growth, respectively, thanks to continued high demand for networking and communications equipment.

ENOUGH MEMORY? The same can't be said for makers of memory chips and microprocessors, the brains in PCs, handhelds, and myriad other gizmos. Falling prices for those chips are taking a bite out of revenue growth. Intel, for example, could see sales rise by less than 10% in 2001--not even half the rate it enjoyed in the late 1990s. It's pinning its hopes on the zippy new Pentium 4 processor, which will run some 50% faster than the previous generation. Consumers, though, may not want to pay for more speed when today's chips can handle virtually any application users can throw at them.

The picture for PCs and chips, in short, is a mixed one. PC makers were clearly sucker-punched by lower than expected demand as the economy slowed--and sales growth won't likely recover anytime soon. Nonetheless, the industry has some bright niches where strong players continue to fight for a piece of growing sales. Even if the PC heads into retirement, there should be plenty of fresh contenders for the title of industry champ.