Sector Spotlight: Only Pollyanna Believes PC Biz Is on the Mend

The Wall Street Journal's "Heard on the Street" column is calling Apple (AAPL) a veritable bargain at 30 times its projected earnings for 2002. Dell (DELL) is up nearly 50% on the year. Yes, one could be forgiven for having thought that the PC business is on the mend.

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But remember that according to the industry's biggest boosters, the companies themselves, it isn't.

Earlier this month Compaq (CPQ) confessed that its inability to refrain from participating in the industrywide price war caused it to miss its already-lowered earnings and revenue targets. Intel (INTC) CEO Craig Barrett went on British television last week to say that the current slowdown could last for up to 18 months. At the CeBit trade show in Hanover, Germany, Hewlett-Packard (HWP) chief Carly Fiorina said that she had no hope of a recovery for the rest of this year, and that the market's weakness was beginning to spread to Europe. Reflecting that concern, H-P has moved its upcoming analysts meeting from Manhattan to Palo Alto, Calif., where the company is headquartered, in an effort to rein in operating expenses.

The Good News

Now, the sector isn't entirely without good news.

PC makers are saying they've gotten their inventories down to comfortable levels. Computer memory producer Micron Technology (MU) echoed that sentiment last week, when it said that in February and early March it was seeing signs of "real demand" from PC makers that had worked through their inventories. Thursday, Ulrich Schumacher, the chief executive of German chipmaker Infineon(IFX), said he viewed recent increases in the spot prices of Dram memory, or Dram sold for immediate delivery, as a sign that the cycle could be turning positive.

It's true that spot Dram has firmed a bit. But there's absolutely no way to tell whether that will continue. On Micron's earnings conference call Thursday, asked whether he expected the tentative strength in the spot memory market to translate into higher contract prices, CEO Bill Stover stayed pretty much mum. "We have seen a tick upward in the spot prices in the past couple of weeks," Stover said. "But we don't know if that's a sustainable trend at this point."

But more important than these stories is the bottom line: Pricing remains extremely aggressive among PC companies. Go to Dell's online factory warehouse and get lost wandering among the thousands of refurbished desktop PCs listed at fire-sale prices.

Take My PC Business, Please

But if you want the best illustration of how bad the PC business is, just look to Micron Electronics (MUEI), the 61%-owned subsidiary of Micron Technologies. Last week, Micron Electronics told Wall Street that its flagging PC business caused it to lose a staggering $168 million, or $1.75 a share, nowhere even close to the 2 cents-a-share profit analysts polled by Thomson Financial/First Call had been looking for in the company's second quarter.

The company decided that the prospect of continuing to get in the middle of the price war between the major PC companies was so unpalatable that the only thing to do is sell the PC business. It's currently in the process of negotiating a deal with Los Angeles buyout shop Gores Technology Group, the same firm that took The Learning Company off Mattel's (MAT) hands for absolutely nothing.

And what will Micron Electronics do without PCs? It's decided to become a pure-play Web-hosting company by setting plans to merge with Interland (ILND) in a stock deal it values at $130 million. Like its PC business, Micron Electronics' burgeoning hosting division, HostPro, also lost money in the second quarter. Interland itself has never turned a profit. Both HostPro and Interland get the overwhelming majority of their revenue from shared hosting, a low-end service with rates between $25 and $200 a month, attractive to small business seeking to maintain a basic Web presence.

"There are deteriorating economics associated with that product," said John Hodulik, analyst at UBS PaineWebber, which co-managed Interland's IPO back last year. "Churn is picking up and margins are getting tighter. This is an attempt for both to gain scale and try to become a low-cost provider." The merger is, in other words, a play to extend both companies' lifelines in a very tough market.

That's how bad Micron Electronics thinks the PC business is. Relatively speaking, the hosting market looks good.

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