US INDUSTRY SECTION SNAPSHOT ON COMPUTER MAKERS
A Reversal Of Fortune In PCs; Former investor darling Dell hits a rough patch while Apple, HP soar

BY PATRICK SEITZ

Three computer makers that were considered has-beens not too long ago are getting a second wind.

Apple Computer has found new life, thanks to its booming iPod digital music player business.

Hewlett-Packard is enjoying a resurgence under new Chief Executive Mark Hurd.

And thin-client computer maker Neoware Systems is seeing heightened interest in its systems because of their security and cost-saving benefits.

The three companies are now the leading stocks in IBD's computer manufacturer industry group.

Meanwhile, long-time leader Dell has been in the doghouse on Wall Street. Its stock has taken a tumble since the direct seller of computer gear missed sales expectations in the August quarter.

The shake-up might seem like a Bizzaro World twist, but Apple, HP and Neoware have earned their place atop the stock rankings, analysts say. The firms have succeeded by finding profitable niches, honing operations and staying fresh.

The shift shows how hard it is to stay on top in the computer industry -- even for Dell, which is highly prized for its efficient operations. Amid falling prices and heavy competition, computer makers constantly struggle to maintain sales and earnings growth.

1. Business

IBD's computer manufacturer industry group contains 16 companies. It includes Dell and fellow personal computer maker Gateway, Neoware, server makers Sun Microsystems and Rackable Systems, and even handheld computer maker Palm.

The push to industry standards has created a punishing environment for many PC sellers. The use of Microsoft's Windows operating system and Intel microprocessors in PCs has turned the business into a commodity game. That's led to bruising price wars among vendors.

In the server space, the march to commoditization using the Windows or Linux operating system continues to take market share from Unix systems.

In recent years, PC makers such as Apple, Dell and HP have been expanding into the consumer electronics business as well.

Dell typically excels when computer products become commodities. It uses its efficient direct sales business model to undercut its rivals on price. Since it doesn't use middlemen to sell its products, it's able to pass those savings on to customers. Also, because it builds its computers to order, it can keep inventory lean and adjust quickly to component price cuts.

But rivals are improving their efficiencies and distinguishing their products through innovation.

HP is pushing novel features in its PCs and printers that competitors don't have. And Apple has stayed ahead of other digital music player makers by continually upgrading its iPod line. The iPod's popularity has helped boost sales for Apple's core Macintosh computer business. (See related story on this page.)

** Name of the Game: The successful computer makers are playing to their strengths. They're focusing on areas where they can differentiate their products and command a price premium. Innovation is critical to avoiding the commodity trap.

2. Climate

After rebounding from the tech slump of the early 2000s, the market for personal computers and servers appears healthy.

Corporations and other big buyers of technology are discarding their "good enough" machines for higher-performance systems, says Mark Stahlman, a Caris & Co. analyst.

"It hasn't been this good in many years," he said. "We're probably in the strongest broad-based upgrade cycle that we've ever seen."

Market research firm International Data Corp. expects PC shipments to rise 14.1% this year to 204.6 million units worldwide. Last year PC shipments grew 15.3%. IDC predicts PC shipments will rise 9.1% to 223.3 million units in 2006.

IDC expects server shipments to grow 9.6% this year to 6.9 million units worldwide. Servers are powerful computers that run networks. IDC predicts that shipment growth will accelerate for the next three years, topping out at 11.8% in 2008.

Much of the growth is coming from lower-cost servers -- a field where HP and Dell compete vigorously.

Thin clients, which offload most computing functions to servers, also are in fast-growth mode. Shipments are poised to increase 46% worldwide this year to 2.4 million units, IDC says.

And they're expected to post compound annual growth of 22% from 2005 through 2009.

3. Market

Price wars have plagued the personal computer industry in recent years. But the pressure is easing as PC makers adopt more rational pricing schemes, says Mark Lanyon, an analyst with Morningstar.

Dell, which sells more PCs than anyone else, has decided to move more upscale. It introduced a new line of PCs in September called XPS. The devices have premium features and come with "white glove" service.

The move is a step away from the low end of the PC market, where vendors deal in high-volume, low-profit machines.

Dell is focusing more on profit margins than gaining market share these days, Lanyon says. It learned its lesson in the August quarter, when it tried to gain a bigger share of the low-end desktop PC business.

"What was a very cutthroat pricing competition very nearly spun out of control as reflected in the Dell results," Lanyon said.

Meanwhile, HP has refined its PC product portfolio and is concentrating on innovative features such as LightScribe. With LightScribe, PC users can burn professional-looking labels directly onto CDs and DVDs instead of using labels or markers.

HP also has beefed up its software business. It recently acquired RLX Technologies, a maker of server blade management software. And it's announced plans to buy Peregrine Systems, whose software manages tech assets and services, and AppIQ, a provider of storage management software.

Neoware has had its own run of acquisitions. Last Wednesday, it announced a deal to buy Maxspeed, a provider of customized thin-client hardware and software. Earlier this year, Neoware bought Qualystem Technology, Mangrove Systems and TeleVideo's thin-client business.

Neoware has been making acquisitions to expand into Europe and Asia, says Keith Schneck, Neoware's chief financial officer. The deals have given the company local presence and intellectual property.

Neoware is the No. 2 thin-client maker worldwide, with 21.3% market share in the second quarter, IDC says. Privately held Wyse Technology is tops with 34.5% share.

4. Technology

PC sales are getting a boost from new technologies, such as 64-bit and dual-core processors from Advanced Micro Devices and Intel. These chip advances allow for faster computing and more heavy-duty data crunching.

At the same time, more computer power is shifting onto networks. So computer users often don't need as much power on desktops. That's good news for the top thin-client sellers -- Wyse, Neoware and HP.

A mix of factors boosts thin-client sales, says Roy Zatcoff, Neoware's executive vice president of marketing and development. "Thin clients are more secure than a typical PC environment," he said. "They're more reliable and easier to manage. Maybe the most important factor for thin clients is they're low cost."

In a typical PC world, one information technology person manages 50 to 100 PCs. In a thin-client world, one IT person can manage thousands of thin clients, Zatcoff says.

On the consumer side, PC companies are offering more devices for managing digital content. Apple, Dell, HP and others are creating devices for enjoying media in the living room and on the go.

5. Outlook

Computer makers look to get a lift late next year from Microsoft's next-generation operating system, Windows Vista.

The impact could be "huge," Stahlman said. "This is a dramatic step up from (Windows) XP."

Windows Vista is designed to be much more secure from viruses, spyware and other threats. It also will feature richer graphics.

The software will require more horsepower than many PCs have today. So another upgrade cycle could be in order, Stahlman says.

Apple's plans to move to Intel processors by June could spark an increase in its Macintosh sales, says Shaw Wu, an analyst with American Technology Research. Apple's next operating system, Mac OS X "Leopard," also is due out late next year.

** Upside: Robust PC sales should continue into next year, with a boost coming from Windows Vista. Adoption of 64-bit and network computing technologies should aid various companies in the field.

Apple's hugely successful iPod business should keep chugging along this holiday season, with a boost from the new compact Nano and a video-enabled model.

** Risks: Strengthening Asian PC makers, including Acer and Lenovo Group, could hurt profitability for Dell and HP.

And Microsoft's already-overdue Vista operating system could run into further delays.

October 31, 2005