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Looking for tech stocks? Try the server market

posted on April 19, 2010 at 5:08 pm
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The Great Recession created quite a backlog in the technology sector.

The average corporate notebook computer is now four years old, according to Needham & Co., and the average corporate desktop is five years old.

That catch-up market is huge. One reason I own shares of both Microsoft (MSFT) and Intel (INTC) in my Jubak’s Picks portfolio.

But the catch-up market for servers, the computers that serve—coordinate, distribute, regulate, and police—networks of users ranging in size from small company networks to the data centers at Wal-Mart (WMT) to the data farms run by Amazon.com (AMZN), Microsoft (MSFT), and Google (GOOG) , may be even bigger. Not in units, certainly, but in dollars.

Intel (INTC) estimates that as many as one-million servers that would have been replaced on normal corporate schedules weren’t refreshed as a result of the Great Recession. Since a mid-range server sells for $25,000 to $250,000, a million catch-up units is a lot of revenue.

But the potential market is much larger than that for two reasons.

First, improvements in server technology make it worthwhile to replace even slightly older machines with new servers. About 40% of the installed base of higher-end servers still run single-core processors, according to market research company Garner. Moving to dual-core, four-core, or even eight-core servers   from older machines cuts power consumption and cooling bills so much that in many cases the newest servers pay for themselves in less than a year, according to Intel.

Second, new technologies such as virtualization, which allows a single server to seem like it is a dedicated computer for multiple user groups, and cloud computing are expanding the market for servers. Revenue from sales of servers fell 19% in 2009, according to market research company IDC. But the sales drop slowed for the server market as a whole in the third and fourth quarters. Revenue for the fourth quarter fell by just 3.9% from the fourth quarter of 2009 and unit volume actually grew by 1.9%. For 2010 JPMorgan is predicting that server revenue growth will outstrip growth for PCs, printers, or storage.

So if we’ve reached that wonderful inflection point where falling sales turn into soaring sales, what stocks should you buy?

Intel is a big beneficiary. The company had lost market share in the server market to Advanced Micro Devices (AMD) from 2005 (88% of the market) to 2008 (70%). But with new server chips, such as the Xeon 7500, set to replace older Itanium processors that required customers to rewrite code when AMD products didn’t, Intel looks like it’s set to regain share in the upper end of the server market. Intel also owns 90% or more of the market for mainstream 2-way servers, according to Kaufman Brothers. (For more on Intel’s most recent breakout quarter see my post http://jubakpicks.com/2010/04/14/update-intel-intc/ )

IBM (IBM), which reported earnings 4 cents a share better than the Wall Street consensus after the close on April 19, is the biggest server maker with a 35.4% share in the fourth quarter of 2009.

But I think No. 2 Hewlett-Packard (HPQ) with its 30.5% share will be a bigger beneficiary of the server recovery. IBM’s service revenue shielded that company from the worst of the economic downturn, but I think that while Hewlett-Packard’s relatively late decision to add more service revenue hurt the company during the downturn, it will now give the company more leverage to what looks like a hardware driven boom. (Hewlett-Packard is scheduled to next report earnings on May 18.)

And finally, for the short-term at least, take a look at VMware (VMW). Servers running Windows operating systems typically run one application per operating system and then, to increase reliability, run each operating system/application pairing on as separate server. That uses less than 10% of a typical servers’ capacity, according to IDC. VMware’s virtualization software allows multiple operating system/application pairs to run on a single server, which while each operating system/application pair behaves as if it is running on its own dedicated server.

In the long-run VMware faces huge challenges from competitors such as Citrix (CTXS), Red Hat (RHT), and Microsoft (MSFT). But in the short-run the stock should be a big beneficiary of the server boom.

I own Intel in my Jubak’s Picks portfolio. You can see all of my Jubak’s Picks at http://jubakpicks.com/the-jubak-picks/

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  • francolargo on 19 April 2010

    I notice that VMW reports after trading tomorrow, the 20th. I use a simple VM Ware program (Fusion) and it is a solid product. Last week there was some buzz that I missed: http://online.wsj.com/article/BT-CO-20100412-710183.html
    Thanks for the idea.

  • Christopher on 19 April 2010

    Actually I’m not too sure if the price range for mid level servers is correct. My company replaced a server that a few years ago cost $25,000 with a server that now costs $5,000 and it gets better performance then the $25,000 server.

    But with that said I do believe that this report is dead on for what is happening, and it will be big for the overall dollars spent. Everywhere you look the IT groups are consolidating old machines into bigger servers that are running virtual machines, and without question the top dog right now in VM software is VMWare.

    BTW in the server world, for a new server, if you don’t have at least 16 cores you don’t even have a server any more. The $5000 server I mentioned above had 16 cores (It also has 16 gig of memory).

  • chapmame on 19 April 2010

    So I take it that this post would serve as an oppurtunity to double down on Intel if Jim were allowed to do so, based on his rules of the road…

  • upickem on 19 April 2010

    I’m not too sure about anything the future holds. What if the globle economy collapses and we all go back to pencil and paper? It’s a Bull Shoot’in world out there. Maybe something shiny in your jewelry box will do.

  • andante on 19 April 2010

    The global traders are betting that Portugal will be next. Flight to safety strengthens the dollar and decreases the price of gold, oil, etc. Good luck.

  • dgoedken on 20 April 2010

    chapmame : Jim has “double downed” previously…though I recall it was his personal portfolio…so, not sure I’d read into anything and only Jim knows how balanced his pers. portfolio is….he may already be overweight INTC and hence not going to add more….

    In short…you can get in trouble reading between the lines…

  • chemace on 20 April 2010

    Its more surprising that he doesnt own INTC in his personal portfolio.

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