DAVID strikes back:

I don't know many people that understand Dell's business better than Randy, but in this instance, I think the glory of such incredible gains this past year may be clouding his thoughts. :)

Let's look at some of Randy's arguments and see where they might not hold water.

1. "Compound this with the fact that the PC business is universally despised as being a commoditized, low-margin affair, and you have a lot of people squawking about Dell's current valuation."

The fact is, the PC business IS a commoditized, low-margin business. The distinction that sets a commodity business apart from a specialized business is either a technological or a competitive advantage that can't easily be overcome by the competition. Dell doesn't offer machines with greater technology than Hewlett-Packard, Digital, Micron, Compaq, IBM, or Gateway. The reason Dell has enjoyed such success is because it has been able to gain market share by competing on price.

While I'll admit that Dell has had a competitive advantage in being the first to sell high-end servers through a mail-order business, that is certainly not an advantage that is difficult to overcome. Compaq is entering the direct market business as we write. It's only a matter of time before there are more companies bypassing the VARs (Value Added Resellers) like Merisel, Ingram-Micro or Tech Data and the retailers like CompUSA and Best Buy. If cost efficiencies are so appealing, the market will be saturated before you know it.

2. "With Dell continuing to take market share in the higher margin server arena and Intel's recently announced 15% price cut on CPUs, clear opportunities for Dell to continue notching up its operating margin still exist."

This might make sense if Dell were also not cutting its prices. Unfortunately, it is. It's also important to note that servers represent just 6% of systems revenues for Dell. This number is growing, but the vast majority of its revenue is still generated from people buying desktop PCs. Dell has recently cut its prices on desktop PCs by 16%.

3. "Dell has been able to grow three times faster than the PC market's 18% growth over the past year because it is taking market share from the industry's number one and two players, Compaq and IBM."

Absolutely. The only reason Dell has been able to do this, however, is because it got out of the retail market and into the direct-mail market. However, Compaq enjoys 7.2% net profit margin in the retail business where there is a "middle-man" involved. (Having a "middle-man" usually means that the consumer has to pay a higher price so that the middle-man can make a profit.) This 7.2% net margin is the same as Dell's margin in the past year without the middle-man. Imagine how Compaq might cannibalize Dell when it gets whole hog into the direct-market business.

Quoting Michael Kanellos from a recent article on CNET, "Compaq is claiming that the operations battle between the two Texas companies has already ground out. 'Our cost structure is as good as Dell's in distribution and better than Dell's in manufacturing.'" If this is true, Dell may be headed for leaner times.

4. "Michael Dell has not been selling any of the 16% of the company he owns..."

Actually, Michael Dell has sold 1.75 million shares since January of 1996, 415,000 of them sold in the last 4 months.

Bottom Line -- Despite the great success that Dell has had over the past few years, Randy's assumptions are somewhat misguided and quite optimistic. I agree that Dell is a fine company with fine management and a fine product. Unfortunately, there comes a time where the stock market's enthusiasm for that "fine" stuff takes the valuation and gets crazy with it. That's called market inefficiency. That time is now.

--David Forrest ([email protected])