As Dell Admits Earnings Hit, the Rest of the PC Industry Remains in Jeopardy

It took a while but Dell (DELL) finally came clean.

After a few weeks of weaving and bobbing, Dell eventually fessed up to the impact that the Taiwan earthquake is having on its operations. For the first time in six years, the Round Rock, Texas, direct seller of computers will miss an earnings estimate. TheStreet.com first warned that Dell was likely to have problems in the third quarter in an Oct. 6 story.

Faced with rising component prices, Dell realized that it could not pass the price increases on to its customers. Although Dell says its troubles are short-term, the rest of the PC industry may face a tough fourth quarter.

Last year, PC companies like Compaq (CPQ) posted glowing fourth-quarter results, thanks to selling high volumes of computers at a time when component prices were low. Although this year component prices were edging higher, in the aftermath of the earthquake it is the component suppliers that have been calling the shots. For example, prices for standard memory have shot up to an all-time high of about $20 per 64-megabit chip, four times the price in June.

But it is not just memory chips. Graphics chips and liquid crystal displays are also scarce. Dell -- with its lean inventory channel --is taking a hit in its third quarter ending in two weeks. Compaq, Hewlett-Packard (HWP) and other low-end PC makers such as eMachines may take a big hit on their margins in their all-important fourth quarter.

The reason: PC makers -- like Compaq and H-P -- who sell through resellers have had to pay top dollar for components to ensure they will have enough computers ready for the big Christmas push.

"Dell will be under temporary pressure now to get components because all the indirect makers had to get their inventory components for Christmas," says an analyst at a money management firm with a large Dell position, who requested anonymity.

PC companies typically carry four to six weeks of inventory while Dell and fellow direct seller Gateway (GTW) carry about a week's worth of components. Once Taiwan production levels hit pre-earthquake levels, Dell and Gateway will benefit from the lower prices. "That's why Dell's fourth quarter should be OK," says the analyst.

Robertson Stephens analyst Dan Niles was concerned about adequate supplies, and downgraded Dell from strong buy to long-term attractive on Oct. 1. Now he says the future doesn't bode well for the entire industry. "This news just plays into the whole theme that Y2K will affect demand and now we have Taiwan affecting supply," says Niles, who warned clients this morning with another report. "Now we know even if you can get supplies like Dell did, your margins will get hit." Robbie Stephens has done no Dell underwriting.

Low-end PC makers, especially eMachines with its razor-thin margins, will have to be watched closely. eMachines plans to go public in the next month or so, and increasing component prices would not be an ideal way for it to enter the public arena. Compaq and H-P, two companies that have been heavily courting the sub-$500 PC user, will see their PC margins crushed in the fourth quarter. IBM (IBM), which has been mum on Taiwan thus far, "could also get crushed," relates Niles.

Dell stock has failed to gain any momentum this year because investors feared its corporate sales -- the company's bread-and-butter division -- would slow due to Y2K. Dell should now report earnings per share of 18 cents, estimates Niles. First Call/Thomson Financial estimates were for 20 cents a share.

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