The market broadsided Intel today, dropping the stock more than 20% in afternoon trading, after it announced an earnings warning for Q3 yesterday due to weak demand in Europe. The market's knee-jerk reaction would be to follow suit and slam the PC box makers, but the story's not that simple. Compaq, for example, announced its European demand is tracking within its expectations. So what's all the hubbub about?
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None of us would admit it, but market sentiment probably causes the better portion of buy and sell decisions. It is easy to understand why Advanced Micro Devices (NYSE: AMD) and other chip makers may move in sympathy to Intel, but how does this announcement affect the box makers? It's not as simple as you may think.
The knee-jerk reaction is to slam the box makers. The logic dictates that if Intel is experiencing weak demand for its chips in Europe, then Europeans must be buying fewer computers and therefore the box makers will lose revenue. Simple. Or is it? If Intel is experiencing weaker than expected demand in Europe, then they must have an oversupply of chips, right? We must presume that they manufactured enough chips to meet their estimated demand, which was too high.
Therefore, they must have extra chips lying around. Extra chips on the market means an over supply. Too much supply means less pricing power and less pricing power means lower prices, right? Lower chip prices is good for box makers. So if the box makers borrow a page from the gas station operators and delay their reaction to the price drop, they can pocket some newfound profit. There's more.
Not all box makers are created equal. Some have high exposure to Europe and others have little exposure. According to my quick calculations, of the major box makers -- Dell (Nasdaq: DELL), IBM (NYSE: IBM), Hewlett Packard (NYSE: HWP), Compaq (NYSE: CPQ), and Gateway (NYSE: GTW) -- Compaq has the highest "outside the U.S." exposure and Gateway has the least. Early this morning, Compaq jumped out in front of the market to quell these thoughts and announced "European demand is currently tracking within our expectations." Well, that settles that. Now we can all go home for the weekend and relax. No worries.
European Exposure
Compaq(1) 55%
IBM(2) 46%
Hewlett Packard 36%
Dell 19%
Gateway 8%
(1) All revenue outside of US and Japan.
(2) All revenue outside of the US.
So, the short-term looks good for the box makers bottom line but bad for their shareholders wallets. Long-term, economic theory (and common sense) tells us that supply and demand should reach equilibrium. Intel will slow up production and supply will shrink, thereby balancing the supply with the demand and prices should return to normal. The box makers will be paying Intel's stated prices again and we are right back where we left off, sans a few hundred billion in market capitalization.
So what was all the hubbub about? Lining the pockets of market makers and providing day traders with some stocks to play with, I guess.
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