The Coming Year: PC Makers Brace for Their Industry's Off-Season

The big question is: Will this strong holiday season carry over into early 1999? Experts say it will.
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Value.

Last year personal computer makers that offered customers value won big, and this year will be no different. It's this cut-and-dried because in a maturing PC market, there aren't that many variables. Apart from adding color.

In terms of innovation,

Gateway

(GTW)

offered leasing programs and opened its own

Country Stores

. Little else emerged unless you count the industrywide rebate packages offered by PC makers. The one big innovation last year was replacing the dull gray by the color teal, which is what

Apple

(AAPL) - Get Report

did with its new

iMac

model, which sold 800,000 last year. Thanks to iMac, Apple's market share doubled to 10% of the domestic market. "November capped off an impressive four-month run for the iMac," says Stephen Baker of

PC Data

.

Already this year, Apple has introduced more colorful models for later this year. Look for other PC makers to quickly copy Apple's blueprint.

Analysts are already seeing signs that the PC rebirth will continue. "We are projecting 17.5% PC growth and over 20% PC production growth in 1999,"

PaineWebber

analyst Don Young told clients yesterday. Young's favorite pick is

Compaq

(CPQ)

, which is gaining share in the indirect sellers market from

Hewlett-Packard

(HWP)

and

IBM

(IBM) - Get Report

, according to the latest figures from

ZDNet's StoreBoard

monthly survey.

Despite its success, Apple's has already lowered prices on the iMac by $100 to $1,199 to appeal to value-conscious consumers. Other PC makers will continue to try to offer everything from free Internet access to PC peripherals at a discount.

Hewlett-Packard, for example, bundled a low-priced PC unit with one of its printer products, and sold over 60,000 units in five hours last month at a price of $899, according to

BancBoston Robertson Stephens

analyst Dan Niles, who has a buy on H-P. (His firm hasn't performed any underwriting for the Palo Alto, Calif.-based outfit.)

"PC units are smoking (and it's both healthy and legal)," says Arnie Berman, managing director of

SoundView Technology Group

. "A growing number of industry players are enjoying such robust business conditions that they believe they have an unusual level of visibility into the first quarter."

Berman's most revealing statistic? About 60% of machines still aren't Y2K compliant. That means corporations will be busily upgrading their systems in the first half of 1999, after their Y2K system checks are completed by the spring. The general feeling is that the Y2K problem will help box makers, at least during the first half of 1999. The second-half outlook is less clear.

All the news out in the industry isn't good, however. Christmas week news that two PC distributors,

Ingram Micro

(IM)

and

Inacom

(ICO)

, were not going to meet earnings expectations may be bad news for PC companies down the line, says Jeff Matthews, a money manager with

Ram Partners

.

"Ingram's announcement that it lost half a billion in sales this quarter is the most meaningful indicator I've seen that we may be in for a change for the worse," says Matthews.

"Other PC distributors such as

Vanstar

(VST) - Get Report

and

Compucom Systems

(CMPC)

also have been seeing sales shortfalls, and these are the biggest corporate resellers of PCs," argues Matthews, who has a short position in Compaq's options. "The retail channel is clearly still losing share."

Expect more sales through the Internet as both Compaq and IBM will move towards a more direct model. Hewlett-Packard -- a diversified giant that has had

trouble devising a cohesive, forward-looking strategy is the last holdout in the reselling space. Early 1999 sales numbers from retail chains such as

CompUSA

(CPU)

and

Best Buy

(BBY) - Get Report

will determine whether the retail channel is still a viable strategy for PC makers.

Investors shouldn't be alarmed when sales figures drop a bit in the first half of 1999. In fact, it's all part of the sector's seasonal downturn. Much like the retail sector, PC companies usually have much better second halves of the year. Last year was no exception. If anything, PC companies could have some upside potential in what is traditionally a slow first half thanks to Y2K. "We see 15% to 20% domestic sales growth in 1999," says Roger Lanto, an analyst with PC Data. "We see a lot of value out there for customers, especially in the first half of the year."

Value. There's that word again.