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In part one of our "Windows winners" update, we focused on the semiconductor company that would benefit from the launch of Windows 8 - Intel (NASDAQ:INTC). This part focuses on the OEMs that will benefit from the launch. HP (NYSE:HPQ) and Dell (NASDAQ:DELL) are heavily reliant on their PC sales for revenues. HP is currently the market leader in PC manufacturing, with a market share of 17.3%. DELL holds the number 2 spot with a 12.1% market share. The stock price of both manufacturers has tumbled due to the slowdown in the PC market. The October-end launch of Windows 8 will change all this. These technology giants are trading at very low valuations (P/E of less than 6x), therefore, we are giving buy ratings for HP and DELL.

The OEMs (Original Equipment Manufacturers) who have been a part of Microsoft (NASDAQ:MSFT)'s Windows ecosystem have taken a toll in the last couple of years. Microsoft's inability to react timely to the changing dynamics of the market has resulted in a global slowdown in PC sales. As the table below shows, growth has slowed down from 15% in 2010 to 0.5% in 2011.

2006

2007

2008

2009

2010

2011

Units (Millions)

239.4

271.2

302.2

305.9

351

352.8

Growth

9.57%

13.28%

11.43%

1.22%

14.74%

0.51%

Dell Share

16%

14.30%

14.30%

12.20%

12.90%

12.10%

Units (Millions)

38

39

43

37

45

43

HP Share

16%

18.20%

18.40%

19.30%

17.90%

17.20%

Units (Millions)

38

49

56

59

63

61

Microsoft failed to react to changing consumer demands and to the rise in the popularity of handheld devices. The Windows Mobile operating systems have failed to make an impact. The Windows 7 was primarily a desktop PC software, which limited its ability to compete with the Android and iOS. This makes the impending (28 October) launch of the Windows 8/WP8 a mega event for the entire technology sector. HP and DELL have taken a major beating due to the slowdown in demand for PCs. We believe they will benefit greatly from the Windows 8 launch. The graph below shows the dramatic decline in the Prices of HPQ and DELL during the last two years. Both stocks are trading at a forward P/E of less than 6x. Therefore, we believe HP and DELL are buys on the October 28 launch of the new Windows.

Source: Ycharts

HP

The table given below shows the revenue breakdown for HP. The company relies on its two major segments, Imaging and Printing and Personal Systems, for growth. Personal Systems accounts for approximately 30% of HP's total revenue. This segment will be affected the most by Windows 8. The previous quarter has been one of the worst for the technology giant. Revenues have seen a 4% decline as compared to 3% growth in the previous quarter. As the table shows, the most significant decline came from Personal Systems. This 9% decline came as a result of consumers holding off on purchases and waiting for the Windows 8 launch. The release of Windows 8 will not only show a recovery, but also lead to growth in Personal Systems, which contributes a significant amount (30%) to total revenues.

The stock is trading at very cheap valuations. The forward P/E is 4x, whereas the P/S is only 0.27x. The P/B is 1.1x. We believe these cheap valuations are unwarranted, and that HPQ is a value stock. The NASDAQ P/E is currently 15x, thus HPQ is trading at 74% discount to the NASDAQ's P/E.

$ million

2009

2010

2011

2012 E

1Q2012

2Q2012

3Q2012

Imaging and Printing

24012

25764

25782

24545

6259

6132

6017

Personal Systems

35305

40741

39574

35927

8873

9452

8620

Change (%)

15%

-3%

-9%

7%

-9%

Enterprise Systems

16121

20356

22241

20496

5018

5211

5143

HP Software

2655

2729

3217

3852

946

970

973

HP Services

35380

35529

35954

34948

8626

8831

8754

HP Financial Services

2648

3047

3596

3804

950

968

935

Unadjus Total Rev

116121

128166

130364

123571

30672

31564

30442

Change (%)

10%

2%

-5%

3%

-4%

DELL

Dell is down 50% from its 52-week high of $18. The primary reason behind this decline is the slowdown in PC demand. While HP has a more diversified portfolio of products, DELL almost entirely relies on its PC segment for revenues. The company has seen falling demand in the last few quarters due to a slowdown in the computer industry and customers waiting for Windows 8. The unit PC sales for DELL have fallen by 2 million between 2010 and 2011. If we look at the company's earnings performance, it has missed analyst estimates in two of the last four quarters. Analysts are expecting an EPS of $1.79 for January 2014. Using the NASDAQ P/E of 15x, we can set a 2013 price target of $27. A price range of $23-to-$30 can be established using the highest and lowest EPS estimates. These targets show a return of almost 200% by January 2014 at the current price of $9.

Conclusion

These OEMs are heavily reliant on Microsoft Windows for product success. We believe the launch of the Windows 8 is going to improve their valuations considerably. Both companies are trading at extremely cheap valuations and can give investors significant returns. These bad valuations are a result of the negative outlook of investors and analysts alike for the PC ecosystem. We believe the Windows 8 launch is going to change all that, and give a boost to Microsoft's ecosystem partners, such as HPQ, DELL and Intel. This makes us bullish on all three stocks. In part 3 of this thesis we will focus on software companies "winning" from the Windows 8 launch.

Source: Buy These Winners Of Windows 8: Part 2