The Dell Tolls
The Bull Argument
By
Rick Aristotle Munarriz (TMF Edible)
By now, the great story of Michael Dell is probably all too familiar to you. The ambitious University of Texas student who began putting together desktop computers in his dorm room. The self-starter who became the youngest CEO of a Fortune 500 company eight years ago. The award-winning master who would grow Dell into the world's leading direct seller of personal computers.
It's an amazing triumph of entrepreneurial spirit, but you're probably not too floored by Dell's awe-inspiring operations lately, are you? You've seen computer makers such as Dell and Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> warn of lower sales in Europe and tumble. You've seen the cyclical semiconductor stocks hit nine-month lows. You've heard that companies spent so much last year upgrading their computer equipment to become Y2K-compliant, that the demand just isn't there right now.
Your eyes and ears have not deceived you. However, your senses have not been feeding you the whole story. There is so much global real estate left for Dell to conquer. There are so many new revenue streams left for Dell to paddle.
While the company's claim to fame was selling computer systems to mid-size and large corporations, you can't ignore the dynamic growth elsewhere.
You see, it's not all about desktops anymore. Portables are hot, now making up nearly a third of Dell's revenues. Its Inspiron and Latitude notebook lines are eating up market share in a booming computing-on-the-go niche.
The company is also making huge inroads in the storage and server markets. The key here is not only Dell's phenomenal growth. That's a lay-up, given the fact that Dell was already an established brand with a track record for superior quality and customer service in the corporate workspace. No, what's important here is that valuations in this sector are much higher, too. Going head-to-head with giants such as EMC Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EMC)") else Response.Write("(NYSE: EMC)") end if %> and Sun Microsystems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SUNW)") else Response.Write("(Nasdaq: SUNW)") end if %>, and walking away with billions in sales and new chunks of market share from companies showing triple-digit P/E ratios, gives Dell plenty of valuation upside in this margin-rich market sweet spot.
Zeke Ashton, who covers Dell for Motley Fool Research, took the time to compare Sun Microsystems to Dell in the latest quarterly report. Dell whips Sun in total sales. It trumps Sun by generating $3.2 billion in free cash flow, too. But, today's market is valuing Sun at 2 1/2 times the market cap of Dell.
Unreal.
Is it the juicy gross margins in the server biz? Is it the growth potential? That's great, because Dell is now the world's second-biggest player in servers -- and growing.
Yes, Dell is doing the right things. Yes, Dell is growing in the right segments. Yes, Dell is succeeding because it is, well, Dell.
"Somehow Dell has been able to take flexibility and speed, and build it into their DNA," said Maytag <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MYG)") else Response.Write("(NYSE: MYG)") end if %> CEO Lloyd Ward on a recent visit to Dell HQ. "It's almost like water. I am trying to drink as much water here as I can."
The company's lean business model has made it the envy of all mass producers. Maytag was not the first company to come knocking for pointers. That is why, if we boil it all down to the original desktop (where I'm sure Paul is going to take his best shots), we have to remember that this is Dell we're talking about here.
The popular argument is that the PC is nothing more than a boxed commodity. With the exception of Apple and its unique operating system, we're talking about similar components and software. Only the names change. The giants assemble the machines, stamp a 25% or so markup over gross costs, and out they go.
But, if they all play the same way, why are Dell's net profit margins more than double that of volume leader Compaq <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %>? The answer lies in the Dell corporate culture. It is the envy of the industry, with its tight cost and inventory controls. It isn't just the direct approach, which can be aped by anyone. It is the experience in flawless execution that is unique to Dell's past and will probably continue in the future.
While most companies carry bloated inventory levels on their balance sheets, nimble Dell records less than a week's worth of sales under that line item. It also collects quickly and holds off on its payables to round out masterful working capital management. Yes, the company is stingy in its operations, but that is strictly by choice. With $8.3 billion in cash and a slew of investments, the company certainly doesn't need to panhandle.
Dell embraces technology as a tool to streamline the business process -- rewarding customers with the bulk of the savings. It's safe to say that Michael Dell and Wal-Mart's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %> Sam Walton would have had plenty in common, save for the decades between them.
That is why Dell, with its picture-perfect direct formula, has been one of the few companies to truly strike e-commerce gold. Half of the company's sales are being placed online now. Forget Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %>. Dell is recording Internet sales that are five to six times higher than the e-tail bellwether. And, for Dell, it truly is the original vision of the online medium -- serving as a way to shave overhead and improve efficiency.
So, all's well that ends Dell. That's why I believe it was premature for investors to bail on the company when it announced weakness in European shipments and small-business orders earlier this month. Despite the warning, the company is still looking at revenues of at least $32 billion this year. That is still 27% in top-line growth under the sluggish, worst-case scenario. Profits, projected at $0.94 a share this year and $1.23 next year, are respectable if not watered down. If the company keeps taking market share in the high-margin workstation, server, and storage markets, it will be a welcome upside surprise in terms of both absolute profits and valuation-widening operating margins.
I also mentioned earlier that Dell still has wide-open spaces left to conquer. While the company is the global leader in direct selling, the whole world's not a stage -- yet. While the company commands 20% of the stateside market and is equally strong in the United Kingdom, it has carved a paltry 5% of the market elsewhere.
That is why, when you hear that sales in China grew by 86% in the June quarter, you begin to realize that the fun is just getting started. That is why, when you see the financial statements and run across jaw-dropping sums like a return on equity (ROE) of 40% or the billions in cash hoarded away, you begin to realize that even if we have an industry meltdown, Dell will always be the last one left standing. That is why, when you see where Dell is heading only to find that it is trading at 22 times next year's estimates -- less than 20 on an enterprise value basis -- while EMC and Sun are fetching 70-90 times year-ahead projections, the relative value will have you rubbing your eyes.
Go ahead, pinch yourself. You're not dreaming. Your senses have simply digested the bigger picture.
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