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Wednesday, June 25, 2008

Tech overview

I had an interview yesterday and the guy had asked me to write up a tech overview. Here you go.

The PC market overall is relatively okay. Desktop is weak – Gartner reported a couple of weeks ago that desktop is down 2% y/y. Notebooks continue to gain share in the market. Most OEMs have benefitted from a weaker dollar and strength in emerging markets. Though the dollar euro remains somewhat constant, the dollar yen has backed up appreciably this quarter. DRAM prices have been going up all quarter, mostly due to capacity cutbacks by ailing manufacturers who have been increasingly shifting their capacity to NAND as the growth dynamics in NAND are more favorable. I think the consumer is the driver for the second half of the year and despite $5 gas, despite a mortgage market freeze, despite what ought to be a pretty lousy job market, consumer spending on PCs continues to be pretty good. I suspect guidance in general from component manufacturers will be in line with consensus, if not a little stronger. I’m worried about summer seasonality and tech stocks. I think, however, the PC market is far more resilient to a consumer slowdown than it has been in years past simply because replacement cycles are somewhat inevitable and internet access has become a service as irreplaceable as the telephone or the television. So I think there’s room for some upside surprise later in the year.

Last quarter, Dell had a good number that surprised the street. They filled the retail channel with product (last year they didn’t have a retail channel) and currency helped them greatly. Backing out the currency gain from the quarter, I think revenues were essentially in line with consensus. I’m not a fan of currency beats. I think Dell has been great at layering on additional product lines like storage and printers but the last one they tried – digital TV – flopped… and they don’t seem to have a new revenue stream in the works. They’ve suggested they’re going to expand their services offerings – instead I see HPQ doing a much better job of it. Dell seems to me like a glorified marketing company. A great marketing company, no doubt… but nothing I’m excited about without some kind of clear change catalyst. I don’t really like Dell.

Apple is gaining a lot of share in the PC market – there will be upside from Macs for the quarter. iPods are running slightly above street consensus, though I suspect the upside variance is likely to moderate now that the iPhone is priced so close to the existing iPod line. The iPhone current quarter sucked but Apple made a wise business decision not to sell people a $400 phone they’d be clamoring for a refund on a month later. Gross margin guidance was very conservative. Last quarter, Apple was working off high priced NAND they had bought in the December quarter. Apple literally did not buy a stitch of NAND for all of the March quarter. They took Samsung and Hynix out of a sizeable chunk of inventory at the beginning of April and will realize a benefit from that this quarter. Also, Macs are overpriced relative to all other notebooks and since the transition to Intel-based systems have the same COGS as the competition. As such, I expect an upside surprise to margins and I expect Apple to continue to gain share as the internet does not require Windows and that’s what most consumers (the majority of their market) use computers to do. The September and December quarter are seasonally strong for the company – back to school is a big driver as is the holiday selling season. The biggest risk appears to be the health of Steve Jobs. I like Apple.

Research In Motion has been a stock I’ve been recommending since February. I have attached a series of blog entries on it. My thesis is that smartphone adoption is a very small part of the market right now – RIMM has roughly 4% domestic share and approximately 1% in Europe. Carriers are poised on the brink of a price war – again. Carriers can charge a premium for smartphone data usage. The iPhone subsidies that bring the phone’s cost down are repaid on the back-end through higher data charges. As only a select list of carriers have the iPhone, it is likely the competition will have to play their best hand(set) which is the Blackberry line. I expect carriers to heavily subsidize Blackberries to compete with the iPhone which will drive penetration rates significantly higher. Over the next several years, I expect smartphone usage to continue to be the big share gain category in cell phones and I expect Research In Motion to be the prime beneficiary of this trend.

Research In Motion has increasingly become a product introduction story – when they intro a new model, they fill the channel with it in almost a staggered but deliberate way, selling each individual model to a short list of carriers that increases over time. Planned for this year are the Verizon “Thunder” (a touch screen model), “Niagra” (an EVDO 9000 series slated for Verizon in May 2009), “Kickstart” (a flip phone, expected in the next 6 months), and “Javelin” (a 3G-less 9000 series). As long as they don’t blow the product timetable, they’ll have an opportunity to seed the channel for the next year. I like Research In Motion. I do however think there is some event risk in front of the quarter as too many others seem to like it right now also – 5 sell side analysts pushed it hard last week – I also noticed that a series of insiders sold into the crest of that reiteration wave. I am not intimate enough with the nuances of the expectations here to say buy it in front of the quarter – I would deem that event risk and try to protect the position accordingly.

Motorola is in serious trouble from all indications from the supply chain. Build rates have sunk to very low levels and have not recovered – their baseline business is just plain lower now. The handset line is perceived as undifferentiated. Their smartphone offering stinks. They seem to be flirting with idea insolvency and I see nothing to turn it right now.

I have been pretty negative on the semicaps for the last year. Memory is a historical record percentage of business (80% at LRCX, 50% at AMAT for example) and the memory business has been decidedly unhealthy. At present demand on a unit basis has remained good and is offsetting the oversupply conditions. A series of DRAM manufacturers cutback their spending and since then the DRAM market seems somewhat more healthy but I fear its misleading. NAND prices are becoming increasingly worse as the cutbacks happened on the DRAM side but stayed relatively constant on NAND. I suspect there will be another leg of downward revisions as we move into the second half and the weight of a heavy retail inventory environment in NAND drags pricing down further. Lam has been indicating they expect an upturn in the fourth quarter. I like Lam on a valuation basis but I think they’re probably wrong about the upturn as NAND has yet to see cutbacks. I like the “story” in Applied Materials, specifically the solar expansion, but the economics of that business for them has yet to be proven and I think it’s become a very generic play for portfolio managers to be long Applied Materials and short others in the group. I can’t really recommend buying any of them.

The hard drive business is interesting to me in that the stocks trade at 6-7* earnings estimates. I am long Seagate and short Western Digital, mostly due to historical disparity between the two – the price differential between them has never been greater. I think Seagate is likely to miss the quarter, partially based on the action in the stock, but I think people selling it at 6* earnings are putting too much emphasis on the intra-quarter noise and the outlook may be better than they think. Last quarter, both companies lowered guidance due to an inventory build and anticipated worsening pricing conditions. They were right. Pricing was terrible, particularly in May as Seagate burned off inventory at bargain basement prices. I think inventory conditions are much better. Marvell indicated they were seeing better than seasonal demand in notebook drive controllers – that’s a good sign in that notebooks carry a higher ASP than desktop drives. Seagate also has seen very little price deterioration in notebook drives… but it represents 15% of business. The desktop and stand-alone HDD markets are where the pricing was most severe, dropping mid-teens intra-quarter. The channel seems to be in better inventory shape now than it was a month ago.

I’ve been good with the SOX this year. I was very bullish when it was 330. I was negative when it was 420. I have been saying that I thought the SOX would trade to 378 where I wanted to be long.

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