When Intel (INTC) warned that PC demand softness in Q3 would lead to lower than previously guided sales, it seemed like the final nail in the PC coffin. The media pundits made absolutely sure to hammer home the point that the iPad (by far the best selling tablet on the market) was "killing" the PC market.
Well, while it is still too early to form any definitive conclusions, it is interesting to note that in its most recent quarter, Apple (AAPL) sold 14 million iPads. While this is a pretty solid number, it is absolutely imperative to take note that the company sold 17 million iPads in the previous quarter. This represented a 17.7% sequential decrease in sales (although to be perfectly fair, this is still a 26% increase year-over-year)
So, let's start with a little background on seasonality. In general, PC-levered companies see stronger sales in Q2 and Q3 than in Q1 and Q4 due to back to school and holiday shopping. However, according to a number of PC-levered companies, normal seasonality did not play out this year. In fact, according to Intel CFO Stacy Smith,
I am less convinced that normal seasonality is a great guide. What we are seeing is that the customers are managing things very cautiously.
Now, there is one really good reason for this cautiousness going into 2H:
Uncertainty Surrounding Windows 8
Microsoft (MSFT) just launched its brand new Windows 8 and Windows RT operating systems on October 26th. However, consumers have known about the imminent launch of Windows 8 for quite some time. Why would consumers buy an older Windows 7 based PC, likely not touch-enabled when the next generation touch-enabled Windows 8 PCs are just around the corner?
Now, a true catch-22 arises: there's no guarantee that Windows 8 will actually be well-received and provide a sufficient incentive to upgrade! Despite the interesting new features and improvements over Windows 7, it is not yet perfectly clear that consumers will view Windows 8 as a worthy successor to Windows 7 or as the next Vista.
In short, OEMs probably don't want to be stuck with a glut of older Windows 7 inventory, but at the same time are not entirely sure that demand will pick up with the Windows 8 launch.
But of course, it would be negligent to have this discussion without mentioning the effects of the alleged tablet cannibalization.
Tablet Cannibalization - What's Actually Going On?
So, there's a lot of talk that "tablets" will kill the traditional PC as we know it. I think this is a half-truth. As it stands, the main differentiating features of tablets are:
- Touch screen
- Long battery life
- Thinness
The trade-off, of course, is that the hardware is generally much less powerful than traditional notebook/ultrabook, and a keyboard is not a standard feature.
So it makes sense that convergence of the "tablet" and the "notebook" is the endgame for the mainstream computing devices. Products such as the Lenovo Thinkpad Tablet 2, the Microsoft "Surface", and the Lenovo Yoga all represent these "converged" devices.
Given that this convergence is the likely goal for mainstream computing devices, is the PC being "cannibalized" by tablets, or is the PC simply evolving?
More interestingly, it seems that 7" (or 7.9" if you're Apple) such as the Google (GOOG) Nexus 7 and the Apple iPad Mini, are in surprisingly high demand. According to Apple, the iPad Mini has sold out, and the Nexus 7 and Amazon (AMZN) Kindle Fire helped boost Android's market share in Q3 to nearly 41% of the tablet market. I believe that for the majority of mainstream media consumption tasks - watching movies, surfing the web, and chatting - the cheap 7" tablets will be where "pure play" tablets will stay relevant.
How To Play It?
Well, if you believe that the Windows 8 release coupled with the next generation PC designs will be enough to sway users to finally upgrade, then the most prudent way to play the rebound is to buy the highest quality companies in the PC space. While the more volatile/less stable companies may offer larger returns in the event that the thesis plays out, the key to capital preservation in case that it doesn't is to own beaten-down but quality companies. Luckily for investors, nearly every PC-levered name is significantly off of its 52-week highs.
Such companies include,
- Microsoft, which yields just over 3%, has a history of increasing its dividend, has a healthy balance sheet with over $60B in cash and just over $12B in debt, and will make money on every copy of Windows sold - ARM (ARMH) based or Intel based.
- Intel - the leading supplier of x86 chips for PCs. Yields over 4% at current levels, generates healthy cash flow from operations, has about $10B in cash and $7B in long term debt, and will be powering the majority of the thin and light notebooks as well as a good chunk of the tablets in the Windows 8 generation.
- Nvidia - the leading supplier of graphics chips for the PC. No dividend yield, but has over 40% of its market capitalization in cash, negligible long term debt, and has scored design wins in many of the major Windows RT machines such as the Microsoft "Surface", the ASUS Vivotab RT, and the Lenovo Yoga 11".
- Atmel - a recently beaten-down stock that develops micro-controllers, and in particular touch screen controllers. As mainstream computing all goes to touch-based interfaces, the need for touch controllers will only grow, placing this <$5 stock with no long term debt and about $272M in cash in an excellent position on a long term basis.
Conclusion
The PC is not dead. Those who require serious computing power will always need higher end laptops and/or desktops. On the other hand, the same group of people for whom netbooks were "good enough", will likely move to converged devices that are "tablets that can become PCs". The "middle class" of computing is what's really up in the air. Will these people move to laptops-that-can-be-tablets (i.e. Lenovo Yoga) with higher end CPUs, more RAM, and so on? Or will they move towards the tablets-that-can-be-notebooks?
Finally, as noted early on in the article: iPad sales saw a sequential decline, and Apple even saw fit to refresh its iPad product very soon into its product cycle. It's not just the PC that is suffering in the short term, it's more than likely broad macro weakness. But the long-term questions posed above are still valid.
Additional disclosure: I may initiate long positions in ATML and/or MSFT over the next 24 hours.
