For almost 30 years, PCs dominated the computing industry. But in the last 2 years the decline in sales is obvious. IDC Worldwide quarterly PC Tracker projected a 7.8% decline in worldwide PC shipments. However, the actual outcome was worse, with more than 15% declines in shipment volume in the second quarter of 2013. Last quarter, PC shipments fell 8.6%.
Going forward, the growth rate for notebook and netbook sales is expected to be around 4-5%. This may sound okay, but consider that just a a few years ago, growth rate was around 24%. This isn't surprising considering how the growth of mobile devices in just a few years have gained momentum. The computing industry has shown a massive shift towards smartphones and tablets in just a few years.
Mobile Traffic Surging
Based on Monetate Q1 2013 E Commerce Quarterly report, the traffic to ec-ommerce websites via mobile devices doubled in the year.
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PC vs Mobile Usage for Ecommerce Sites (source)
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Breakdown of Each Device Type (source)
So what does this tell you about the development in the PC industry? Are tablets and other mobile devices the future of computing?
The Rise of the Tablet and Portable Mobile Internet Device
Tablets were meant to be a media consumption device, but it has broken all convention and is now being used as a productivity device. Though not as powerful as desktops, mobile devices are developing in rapid speed to keep up with the needs of users. An example of how mobile devices are adapting to extreme changes is the massive development of apps. To date iOS and Google Playstore have more than 1 million apps respectively, and growing day by day.
New mobile developments continue to come out and now we are so used to doing things on our devices like mobile banking, purchasing online, sending money to family, accepting credit cards, project management, booking reservations and so on. Expect to see more mobile devices eating up the PC market share.
DELL Left the Party Early
The introduction of the iPad in 2010 caught everybody off-guard. Especially PC makers. People made fun of the name and predicted that it was just a fad that would die out. Who knew that a single device would shake the entire computing industry.
Michael Dell took Dell private in order to revive the business around its enterprise solutions, away from the pressures of Wall Street.
[we] need to restructure to cope with the computing landscape away from the pressures of quarterly reports from Wall Street and focus as IBM does on providing its storage servers and services to public organizations and large companies.
By the time the deal for DELL closed, it was trading at a cash adjusted PE of 4.5, P/B of 2, with a ROE of 12% falling from the high 30% range. Michael Dell may have bought the company at a cheap price, but it does prove that the PC industry is not what it used to be.
DELL Intrinsic Value Should Have Been Above $20
As a case study, here is a previous stock valuation article on Dell.
HP Showing Strength With its Business Solution
In the past year, HP's (HPQ) market share has been increasing. The stock price has been rewarded with a 85% boost YTD.
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HP Leading Market Share (source)
The good thing is that HP positioned itself strategically as a business device, that's why it still sees stability despite the decrease in PC sales. But legendary short seller Jim Chanos is publicly short HP, citing that its core business is declining.
Last year, he shared a presentation on HP where he also labeled it a value trap citing 5 key points.
- Cyclical and/or overly dependent on one product
- Hindsight driving expectations
- Marquis management and/or famous investor(s)
- Appears cheap using management's metric
- Accounting issues
So what has HP done right then? Here's a quick look at the change in HP strategy leading to success so far.
- Move HP into higher value, higher margin growth categories
- Sharpen HP's focus on its strategic priorities of cloud, solutions and software with an emphasis on enterprise, commercial and government markets
- Increase investment in innovation to drive differentiation
The strategy doesn't include much talk about its legacy PC business. At least HP knows that the industry has changed and the market is rewarding it for this new direction.
From a numbers point of view, it isn't a bad short. But at the same time, if you believe that the focus on the death of PCs is overblown, it's a pretty good value play too.
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Source: OSV Stock Analyzer
If HP's enterprise focused strategy continues to play out, the intrinsic value should look like this.
HP's Intrinsic Value Above $30 level
Microsoft's Strategy in the PC Space
Let's look at this whole topic from another angle. By thinking about the expected growth of Microsoft's business, it can give you insight into the PC industry. Microsoft isn't a fully integrated hardware manufacturer but PC sales certainly matter a lot to the business. You can't sell software unless the hardware is available.
Look at the way revenue is divided (thanks to Trefis). Microsoft Office is the number one revenue generator. Microsoft is making money from licensing-- so the more computers to install Office, the better.
Trefis has a price target of $42 on the stock price vs the current $38.16.
If I run a simple reverse DCF by using the TTM FCF of $23.5b and 9% discount rate, the current growth rate baked into the price is 2%. Even though MSFT is a cash cow and pumps out FCF each quarter, it has been inconsistent over the past 5 years.
Previously it was easy to assume a growth rate of 10%, but as more money is spent on capex to gain traction for cloud based business, I expect it to grow between 4-8%. This equates to an intrinsic value range of $42 to $51.Thoughts on the PC Industry
It is true that the PC industry is slowing down. Dell went private to hide from public scrutiny, HP is focusing on new strategies and Microsoft OS sales are slowing down. Growth in the industry is in the single digits compared to 20+% growth a few years back. But will it die like the cassette tape? Doubt it.
In value investing, a lot of emphasis is placed on bottoms up investing, but at the same time, value investing also involves understanding the industry. With the way the industry has been trending, does this mean that the companies mentioned have a high chance of becoming value traps?
What I do know is that the PC industry and players in this space have become a whole lot more difficult to analyze since the tablet explosion.