July 28, 2010 – PCs: Raging at the Dying of the Light

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Now in its 30th year, the PC market is enjoying an upgrade-cycle fueled rebound from a recession induced dip.  However, an alternative approach, by which mobile non-PC devices, like smartphones and tablets, access apps running on large centralized “cloud” servers, threatens the x86/Windows architecture in the same way that the PC threatened the minis and mainframes that came before it.  We believe that the demand for desktop PCs will wane, as virtualization and cloud applications allow many users and organizations to skip future upgrades and downscale configurations.  Mobile PCs, the primary driver of industry growth, will feel pressure from the cloud-enhanced capability of non-PC tablets and smartphones.  PC-based servers will suffer from ASP degradation with an on-going shift to lower cost rack-mounted blade servers.  As such, we expect a comprehensive and irreversible shift away from PC architecture will be evident within 5 years

2009 was a tough year for PCs, with global recession punctuating a relatively tepid three year reception for Microsoft’s Vista PC operating system upgrade.   While the 4Q09 intro of Windows 7 prompted anxiety, 1H10 results along the PC value chain suggest that some of the aging installed base of XP desktops is being replaced, yielding a flat rather than declining demand curve.  This is augmented by rapid growth in notebook and netbook PCs, particularly in the consumer market.  At the same time, the rapid growth of dense, rack-mounted blade servers for private virtualized systems and cloud providers is offsetting a decline in traditional enclosed servers

The simultaneous rise of portable computing platforms and Internet resident cloud applications benefit the PC value chain in the short run, but will sap demand for powerful and interoperable PC-based user platforms as alternatives gain momentum.  Smartphones and non-PC tablet computers have great appeal from their superior cost, portability, ease of use and communications capability, while cloud-based applications on powerful shared servers allow users to work effectively with the more limited processing and storage capability afforded by mobile platforms.  Enterprise desktop PCs will see pressure from inexpensive “net-top” computers, which can run Windows applications off of virtual and cloud servers whether or not the “net tops” have PC architecture.  This paradigm change would hurt the entire PC value chain, creating opportunities for non-PC architectures

Rack-mounted blade servers are less than 15% of the total server market, but are growing rapidly, particularly relative to traditional enclosed tower servers, which can be installed on racks, but with far less density and at much higher costs than blades.  We expect equilibrium to tip decisively toward large, dense cloud hosting installations and virtualized enterprise data centers, favoring an even sharper shift toward the lower cost blades and an increase in the bargaining power of customers.  This shift would affect systems vendors far more than semiconductor or software suppliers

We do not expect the decline of the PC to be immediate or abrupt.  Strong momentum for notebook and netbook platforms has yet to be tempered by either tablets, demand for which was only recently kickstarted with the iPad, or Smartphones, which have relative input and display shortcomings vs. PCs that are yet to be addressed by vendors.  Moreover, technology demand has significant inertia – the IBM 360 mainframe is approaching its 50th anniversary and still has annual sales of more than $10B.  However, we do believe that the market and technology trends will result in a life-cycle inflection point for total PC-architecture demand within 5 years and that the coming erosion of the category will become apparent to investors even sooner

A shift away from PC architecture at the device level would have its greatest impact on PC systems vendors, the largest of which are HP, Dell, Lenovo and Acer, PC dependent semiconductor vendors, such as Intel, TI, AMD and NVIDIA, and PC disk drive suppliers, such as Seagate and Western Digital.   The future for companies in these categories will depend on their ability to offset future PC market deterioration with success in alternative devices and servers.  PC software publishers, such as Microsoft, Symantec, Adobe, and others, have largely already begun to see a shift toward server based products, often running on virtual machines or clouds, away from higher revenue, but lower margin PC applications.  Here we expect the opportunity to be strong, albeit with a wide opening for competitors to enter a previously concentrated market

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