The Plight of Traditional US PC Makers
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Dell (NASDAQ: DELL) reported terrible first quarter 2012 earnings; their stock dropped 17% to a new 52 week low on this news, in fact the stock dropped the most since 2000, and Dell is not alone when it comes to bad news with PC makers. HP’s (NYSE: HPQ) CEO Meg Whitman has announced that the company will be cutting 27,000 jobs in order to restructure its business after their profits dropped over 30% in the last quarter. These layoffs represent the largest layoff in the Silicon Valley pioneer's seventy three year history. However there is still a successful consumer PC maker, Lenovo.
In Dell's case, profits dropped 33% and that was even worse than the low expectations analysts polled by FactSet had predicted. Dell also stated, for the first time, that they were facing competition from Apple (NASDAQ: AAPL) products in the business market, which is not a new phenomenon but its recognition is. Dell management also said that spending on desktops and laptops remains pressured and they believe some large volume customers are holding back on large purchases due to macro-economic worries. Dell sits between low cost PC makers like Acer and Asus and higher end PC makers like Apple and the ThinkPad line, made by Lenovo.
With soft PC sales likely to continue into the future, Dell has been trying to diversify its offerings with other tech based products such as business, security and network offerings. If these businesses catch on they could be higher margin, and Dell has made some acquisitions such as Force10, SonicWall and Perot Systems in an attempt to boost their footprint in other tech sectors. This diversification has put Dell ever more in competition with tech giants like IBM (NYSE: IBM) and Oracle as well as trying to compete in their traditional low margin PC market where they face HP and Apple domestically and a host of overseas competition such as Lenovo. Sterne Agee estimates that 70-75% of Dells’ business still comes from PC related sales. Dell has also tried their hands at making an Android device, the Dell Streak which has since been discontinued, though a version of the Streak may launch running the forked version of the Android OS made by Baidu called Yi. Dell is just starting the turnaround process and it remains to be seen whether they can be successful in it.
The other American PC maker that is not doing well is HP. HP’s revenue dropped 3% in the first quarter and the 27,000 layoffs, to be completed in fiscal 2014, are aimed at saving the company up to 3.5 billion dollars annually. CEO Meg Whitman announced a shift to a three pillar strategy for HP going forward; cloud, security, and information management. Consumer hardware manufacturing is not one of their three new strategies going forward. One of the main issues going forward is that HP plays in a lot of markets, some new and some old but they don’t lead in many if any markets. The layoffs and drop in revenue overshadowed what were actually better than expected quarterly results. HP did report over one and a half billion dollars in profits though that was down from 2.3 billion during the same period in 2011. HP has also had three CEO’s in the past three years and instability at the top of the management team does not bode well for stability throughout the company.
After spending over a billion to acquire Palm in 2010, HP announced in 2011 that they were exiting the tablet and mobile market, which is dominated by Apple's iPad, to focus on higher margin businesses. They also flirted with the idea of spinning off the PC division completely as IBM did in 2005 when they sold their PC division to Lenovo, though this did not come to pass. HP is further along in the restructuring process than Dell but both suffer from stagnating North American and European PC sales, both companies face uncertain futures as they attempt to shift away from the highly competitive low margin consumer PC business.
Lenovo on the other hand is not being held back by western markets. Lenovo announced a 59% increase in quarterly net profit, a far cry from the huge dropped in profit that HP and Dell experienced. Lenovo has taken a somewhat different approach than other PC manufacturers, as HP and Dell move to higher margin businesses Lenovo is focusing on volume. Their net profit margin globally is below 2%. Key to this strategy was the acquisition of IBM’s PC business that took place in 2005 and the growing Asian PC market. PC penetration in China stands between 20-30% whereas it is 99% in the US and Lenovo has 30% of the Chinese market and is looking to grow that market share. This has made Lenovo the second largest PC maker in the world putting it just a few percent behind HP. Lenovo looks like it will surpass HP in the next few years. Lenovo has also made recent hardware acquisitions including the Japanese computer maker NEC and Medion a German consumer electronics company. Lenovo has thus far stayed away from services unlike the US based competitors and focused on growth and cost controls.
Dell and HP are both down roughly 15% so far this year, and both are also down over 50% in the last five years, whereas Lenovo is up over 80% over the past five years. Lenovo has very low profit margins, significantly lower than the already slim margins of their competitors HP and Dell. Thus far Lenovo’s success has been fueled by huge growth in their domestic market. Furthermore, they have not had the management issues that HP has had or the need for the founder to step in to try to save the company as happened with Dell. Going forward we will see Lenovo diversify so that they provide a full ecosystem of devices; desktops, laptops, tablets, smartphones and TVs. This strategy will set up years of growing market share and profits for Lenovo as its US competitors attempt restructure. This will additionally put Lenovo in evermore competition with Apple, which has a high margin and a high quality product portfolio that has grown Apple into the most profitable tech company in the industry.
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