The Fall and Rise of PC Giants

This afternoon, the Feds likely to announce its fifteenth interest-rate hike since it began raising rates nearly two years ago.

Thats one heck of a run!

But after all that tightening, our Money and Markets editors tell me money is actually looser than ever …

Money supply growth is zooming ahead.

The prices of gold, silver, platinum and other metals are setting multi-decade highs.

And long-term interest rates have barely budged from where they were before the Fed started hiking.

So until you see some kind of a disaster in the U.S. economy, maybe due to a housing bust, the Feds got to keep hiking rates!

What bothers me is what higher interest rates are going to do to an already-battered U.S. tech industry. Consider, for example …

The Fall of the
Dellioinaires

At the height of the dot-com boom, I lived in Austin, Texas.

I personally watched the rise of Dell turn several of my neighbors into Dellionaires.

Understandably, those Dellionaires are very loyal Dell fans. They dont seem to care that Dell has lost more than 50% of its market value from its dot-com peak. They dont seem to mind that Dells stock hasnt split since 1999 or that Dell is within a buck and change of hitting a new 52-week low.

Hell or high water, my Dellionaire friends are still convinced that happy times for Dell are right around the corner.

Hope springs eternal. Thats fine. But ignoring the dire reality can also be very dangerous.

I dont say that because Dell makes bad computers or is poorly managed. Its because …

Dell Is in a Dogfight Against
Competitors It Just Cant Beat:
Chinese PC Makers

Take Lenovo, for example.

Less than two years ago, very few people had ever heard of this PC company based in Mainland China. Then, on December 8, 2004, seemingly out of the blue, it burst into the headlines with a big splash.

The big news: Lenovo bought IBMs personal computer division for $1.75 billion. IBM! The company that created the PC industry as we know it today, the company that launched Microsoft into the world!

Lenovo acquired IBMs entire global desktop and notebook computer business and immediately transformed itself into the third largest personal computer company in the world, behind Dell and Hewlett Packard.

Not bad for a company that was founded just 22 years ago … by a group of ten Chinese professors … in a small cottage … with only $25,000 in start-up capital!

Of course, it didnt hurt that the original company, New Technology Developer Inc. was backed by the Chinese Academy of Sciences.

Nor did it hurt that its successor company, Legend, was the first to develop a Chinese-character card, receiving the highest National Science-Technology Progress Award in China.

When the company bought IBMs PC and notebook divisions, Lenovos chairman explained it this way:

The historic moment marks a strategic breakthrough in our efforts to establish our PC business overseas. The blending of IBMs penetrable marketing and sales network with Lenovos high efficiency in product design and manufacturing, as well as good understanding of Chinas huge potential market, promises a stunning success.

Boy, is he right!

Lenovo was an insignificant Chinese PC maker that was struggling to compete in the global marketplace. Now it has the size, muscle, and strength to become the worlds largest computer maker, surpassing both Dell AND HP.

My Dellionaire Friends May Not Be Worried
About Lenovo. But I Bet Michael Dell IS!

Especially after what happened last week!

Last week, the U.S. State Department announced its going to buy 15,000 computers from Lenovo.

Yup, 15,000 computers!

From a company controlled by the Chinese government.

Granted, the total value of the purchase is only $13 million. Not penny change. But also not a huge deal for either company. But you can bet your boots that the people at Dell werent very happy to hear this news.

Look! when your own government starts buying its computers from your Chinese competitors, youve got to get the message that somethings seriously wrong … that the business pendulum has swung over to China.

This purchase is drawing some heated criticism. A lot of people are concerned about Chinas growing economic power … and for good reason: Chinas eating everybodys lunch. Even the choice morsels on the plate of technology behemoths like Dell.

The big picture for the PC industry:

Those 15,000 computers are just a small appetizer in comparison to the veritable FEAST Lenovo is planning to snatch away from Dell and HP.

Lenovos $599 Laptops

All the tech titans are assembled at the Cebit Technology Show in Hannover, Germany this week to view the newest, fastest, and sexiest tech gadgets.

Lenovo was there showing off its new laptop, the C100, selling for only $599.

Yup, 599 measly dollars.

Sure, Dell also offers specials and rebates that approach this price range. But this isnt a stripped down, quasi-useless laptop either. It comes with a 3-in-1 multicard reader, 4 USB ports, an integrated wireless card, a generous 15-inch XGA screen, 256 megabytes of memory, a 40 gigabyte hard drive, 1.7 GHz processor, a DVD player, and Windows XP.

In response, Dell now offers a $150 rebate on its bottom-of-the-line Inspiron B130 laptop, bringing its net price down to $499. Plus to bring it up to speed with the Lenovo, it throws most of the same features as free upgrades. That keeps them competitive in the marketplace. But how they make a profit on this stuff beats me.

It doesnt matter how much of a head start Dell has in the competition for industry supremacy. Remember, IBM originally had a head start that was miles long. Heck, it was practically the only one in the whole darn race!

Dell will have only two choices:

A. Slash its already dirt-cheap prices even more, killing whatevers left of its profit margins.

B. Yield the number one spot to Lenovo, and eventually, maybe even exit big segments of the PC industry!

Ask yourself, how much profit do you think there is left over on a $599 laptop once you buy the hard drive, RAM chips, screen, Windows, the microprocessor, and all the other parts that go into making a laptop?

Ill tell you the answer: Not very darn much!

The Lost Low-Cost Shoe

The world beat a path to Dells door because it was the lowest cost producer of computers on the planet. That low-cost shoe, however, is now on Chinas foot. And even all the magic of all the Fairy Godmothers wont get it back.

Goods produced in China are cheaper for the simple reason that Chinese wages are a fraction of U.S. wages.

In rural China, 250 million people earn less than $1 a day. Another 700 million earn less than $2 a day.

On average, the annual income of Chinas 1.3 billion people is about $1,800. On top of that, the typical Chinese factory worker puts in 10 hours a day, six days a week. Thats 60 hours a whopping 50% more than their American counterparts.

Hows Dell going to compete against THAT?

It cant.

The consequences are dire. Even Dell management admits as much. Dick Hunter, the head of U.S. manufacturing for Dell warned:

I tell employees all the time that were in a race on costs. When we lose the race on costs to Asia or wherever, that puts our own security in jeopardy. (emphasis added)

Is Dells security in jeopardy? Heck yeah!

Whats Dell Doing About This?
Not the Right Thing, In My View.

Dell isnt going to roll over and die. In fact, right now, its trying very hard to reinvent itself so that it doesnt have to compete head-to-head against a competitor that it simply cant beat.

The concept: To transform itself into the Cadillac of the PC business.

At least thats what it looks like to me, especially after two separate moves the company made last week:

First, Dell bought Alienware, a maker of high-performance computers that are popular with the video-junkie crowd.

My oldest son has been begging me for a hyped-up, blazingly fast Alienware computer for years, but I wasnt about to spend $3,000 or $4,000 for a computer just so he could play faster video games with fancier, hoopteedoo graphics.

Im sure the profit margins of those $3,000 to $4,000 computers are nice and fat, certainly a lot more than $599 laptops and $499 desktops.

But how many companies are going to want to multiply their costs by five or tenfold just to be fancy? And how many parents are going to finance their kids video game habit.

(Pssst. An important side note: I also want to point out that Alienware substantially achieves its blazingly fast speed from its use of AMD chips. And Im convinced its only a matter of time before Dell makes the switch from Intel chips to lower cost AMD chips. Thats why Intel investors should be just as worried as Dell investors!)

Second, Dell announced that it will start selling computers with 20-inch flat screens in the second half of this year. This move is designed to justify raising its average selling price and puff up Dells shrinking profit margins.

Will it work? I doubt it. In the PC olympics of years past, every race for the gold was won by the lean-and-mean companies offering the least expensive solutions.

But I do think it will be a big boom for the big flat-panel screen makers like AU Optronics, Chunghwa Picture Tubes and Quanta Display, all of which are located in Taiwan.

The personal computer business may be mired in a brutal price war. But the growth in video-enabled mobile devices video players, cell phones, hand-held video games, personal digital assistants is going to give a huge boost to low-cost, efficient flat panel and LCD screen makers.

Whats a Tech Investor to Do?

Remember the $250 calculators that now cost less than $5 and the $500 DVD players you can now get for $25? Thats the slippery slope PCs and laptops are on.

And not only is the PC business morphing into a cheap commodity business, U.S. companies are also fighting against a new low-cost provider they cant possibly beat.

So your first and most urgent step is very simple: If you own Dell, Hewlett Packard, or Gateway … run like the dickens. Dont look back. Dont even think about the price you could have gotten if you had done it six years ago … or the losses you could have cut if you had sold at some subsequent peak.

Just run.

Your second step: If you own Intel, the high-priced processor provider, also run for the hills!

As the price of computers falls, computer makers have no choice but to use the lowest-cost component providers they can possibly find. And in the processor battlefield, AMD is the long-term winner.

Am I suggesting that you should buy Lenovo stock? Heck no. Even with the lower wages in China, Lenovo is still stuck in an industry characterized by falling prices and falling profit margins. Those are not the types of businesses I want to invest in.

Instead, I think your third step should be to recognize that computers are not going away. Quite to the contrary, the cheaper they get, the more widespread their diffusion to the four corners of the earth, especially into the living rooms of the average middle-class family.

And right now, the sweetest part of the PC food chain to invest in is the companies that enable computers to become entertainment devices.

Im talking about graphic chipmakers that can process video images with breathtaking speed … the screen makers that produce crystal clear images … and the companies that make it possible to wirelessly connect your PC to other consumer electronics like TVs, speaker systems, cell phones, DVD players, satellite radio, and more.

And like Lenovo, the vast, vast majority of the companies at the cutting edge of this innovation parade are found in Asia.

Which companies should you pick? I will soon be launching a new publication thats dedicated to giving you that answer. (More details to come.)

In the meantime, though, here are a few mutual funds to look at with a nice chunk of their assets in foreign tech companies:

Firsthand Global Technology (GTFQX), with 58% of its assets in foreign tech stocks
Janus Global Technology (JAGTX), with 48%
Wasatch Global Science and Technology (WAGTX), 38%
Henderson Global Technology (HFGCX), 36%

I wouldnt plow big money into these, though. Id save most of your tech-stock money for the sharp-shooter rifle strategy Ill be giving you in my new publication.

Besides, the time to buy is on dips.

We should be getting one soon. But right now, even some of my number one favorites are temporarily a bit rich for my blood.

Best wishes,

Tony Sagami

For more information and archived issues, visit http://legacy.weissinc.com.

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Jennifer Moran, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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