Dueling Fools
July 07, 1999

Farmers in the Dell
Bear Argument
by Rick Aristotle Munarriz
([email protected])

Arrogance kills.

"Our business model has been so resilient that there's almost nothing we can do to screw it up," Michael Dell said two weeks ago at the Forbes CEO Forum in Atlanta.

Those are some pretty cocky words for a leader who filed to sell four million shares of the company just five days later. Some confidence, right? With the stock trading for a third less than it was just five months ago one would think that Michael would be buying -- not selling.

Then again, Yi-Hsin may argue, selling is what Dell does best. It's hard, even as a bear, to not look back in awe at what Michael Dell has accomplished. From his Longhorn college days until just a few quarters ago Michael was all about selling desktops and surpassing expectations.

Times have changed. Dell is no longer beating analyst projections. Margins are slipping. As sure as Michael may sound when he is bragging about his company's business model, the reality is that his competitors have caught on. I think he mistook "resiliency" for "clone-ability." Compaq <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %>, which continues to hold a commanding market share lead over Dell -- 40% more worldwide -- went into direct marketing six months ago.

Michael Dell carved his company some cozy digs, but in the process of tooting his own horn with the financials to show for it he has invited the competition to take its business model and bolt over to Kinko's.

Dell, in response, has moved away from its core market of selling desktops to medium and large corporations. It is now making a concerted effort to peddle servers and workstations to companies of all sizes. Dell is also gunning hard for the home market. What does all this mean? It means Dell is retreating from the high margin camp that is now being raided and it's now being transformed into just another all-purpose computer company.

The shame of it all is that the computer has become a commodity. Dell has been forced to lower prices at a faster pace than the decline in costs of its components. Either that or the production efficiencies just aren't coming along quickly enough. How else would you explain the falling margins?

Prodigy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PRGY)") else Response.Write("(NYSE: PRGY)") end if %> and America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> through its Compuserve Internet Service Provider are now offering free computers in exchange for three year service contracts. Sounds cellular? Sounds set-top? Sounds commodity-driven? Cheap personal computers are flooding the consumer market and if the tide continues to rise you have to believe that corporations are the next target on the list. Where does that leave Dell? One of the many brand names where the consumer is growing educated enough to go generic?

The whole sector is heading into some uncertain times. Sure, sales growth is a lock at the unit level -- but at lower, cutthroat prices and margins. Do you really want to be buying a commodity stock at Dell's lofty valuation? The company's market cap is more than double Compaq's market sum. Meanwhile, Compaq is just 18 months removed from a year in which it earned $1.9 billion -- a milestone Dell has yet to reach.

Today Dell's peers are in trouble and Michael is taking in some graveside whistling. He points out how in the last quarter the company had 55% of the sector's profitability on just 10% of the sales. That kind of acrobatic bravado is mighty dangerous for a company selling at more than fifty times earnings. One slip and the first step is a doozy. Then the dirt shovels on in. Then the bulls of this Longhorn alum get the horns.

Next: The Bull Responds