Have you bought a personal computer lately? Probably not, and neither have your friends. Technology research consultancy Gartner Group just released a report showing an 8.3% year-over-year drop in global PC sales in September, the worst annualized drop in recent memory.
And things are likely to get even worse in coming quarters.
At least that's the view of short sellers that are increasingly targeting this sector. If these short sellers are right, then a major industry shakeout may be coming. And if you're a value investor, then you need to watch how this trend plays out, because some of these very same stocks could turn out to be the top bargains of 2013.
Windows to the rescue?
In recent weeks and months, tech watchers have been suggesting that slowing PC sales are the result of a decision to wait for Microsoft's new version of Windows, known as Windows 8, and set for release on Oct. 26. In fact, the beta testers for this software have delivered positive reviews, reporting that Microsoft (Nasdaq: MSFT) has finally delivered an operating system with the look and feel of the best operating systems offered by Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG).
There's just only one problem: Consumers and businesses no longer need to upgrade their computers every two or three years, as today's security software does a much better job of keeping these machines from getting bogged down with viruses and malware. It's why short sellers figure there won't be much of an upgrade cycle this fall and winter, and expect shares of Microsoft and other companies to feel the heat.
How bearish are they? They boosted their short position in Microsoft a whopping 19% in just the two weeks ended Sept. 28. The 102-million-share short position is now the fourth-highest of all Nasdaq stocks, right behind Sirius XM (Nasdaq: SIRI), Frontier Communications (Nasdaq: FTR) and Intel (Nasdaq: INTC).
That's right, Intel, the world's largest chip maker, touched 52-week lows in recent sessions. The old adage still applies: As goes Windows, so goes Intel, which has thus far largely missed out on the tablet-computing revolution. The chip maker can ride out this storm, however, as it carries more than $7 billion in net cash on its books.
The same can't be said for rival AMD (NYSE: AMD), which has only $1.2 billion in cash against $2 billion in debt. This may explain why the short position in AMD, rose from 121 million shares to 142 million in just two weeks. AMD is in the crosshairs of short sellers even though it is already treading water around its 52-week low.
Another stock seeing a double-digit jump in the short position in two weeks: Hewlett-Packard (NYSE: HPQ), the world's largest seller of PCs, which has also been testing 52-week lows in recent sessions. The fact that short sellers are making big bets on these stocks -- even after many of them are near 52-week lows tells you that they expect things to get a lot worse before they get better.
The 2013 reversal
Yet here's why you need to monitor this situation closely. If short sellers are right, then the industry dynamics will be inexorably altered, creating clear long-term winners among the survivors. For example, if AMD's woes deepen and the company generates losses in coming quarters rather than the expected small profits -- which is more likely to happen -- then the company's research and development budgets would need to be slashed. It would then become ever harder for AMD to keep up with industry leader Intel. This means Intel may be looking at a smaller market share in 2013 and 2014, but can capture a bigger slice of that pie once AMD proves to be a weakened rival.
In a similar vein, box makers such as Dell (Nasdaq: DELL), Hewlett-Packard, Acer and others are probably questioning their long-term commitment to this industry, which carried razor-thin profit margins during the good years, and perhaps flat to negative margins during a falling sales environment. Here again, if any major player decides to reduce its role in the PC market sharply, then the other players would be able pick up market share and rebuild scale economies in manufacturing and distribution.
My favorite PC play remains Micron Technology (NYSE: MU), which could become a key player in PCs as the migration from disk-drives made by the likes of Western Digital (NYSE: WDC) and Seagate Technology (NYSE: STX) to flash-based, solid state drives (SSD) plays out. Micron and other SSD makers can offer lightweight, longer-lasting drives that also have faster seek times.
Risks to Consider: PC sales are sluggish now and would become even weaker of the U.S. economy stumbles badly in 2013.
Action to Take --> These heavy short positions mean you need to proceed with caution with these stocks. But it's also important to know that clear bargains will eventually emerge, so stay abreast of industry events this autumn and winter as the PC industry is bound to be on a bumpy ride, and you may wind up with a nice rebound stock on your hands.