Dell (DELL), like the rest of the WinIntel ecosystem players, has been savaged in the last year due to concerns about the falling sales of PCs. Dell, which is the 3rd largest seller of PCs after Lenovo (OTCPK:LNVGY) and HP (HPQ), has seen its share price fall by a quarter in the last one year. IDC reported that PC sales have fallen the most in 3Q12 since at least 2001. The rise of smartphones and tablets has cannibalized the sales of laptops and PCs. With most of the common PC functions like web browsing, email and games available on cheaper and faster tablets, desktops are facing an uncertain future. The hopes that a new version of Microsoft's (MSFT) Windows Operating System would revive the PC market are also fading. MSFT has hedged its bet on the PC market by making its O/S tablet and smartphone friendly. But for hardware players in the WinIntel system, the transition to tablets and smartphone is much harder. HP's acquisition of Palm and the introduction on tablets has been a major disaster. Dell has also failed miserably with its entry into the smartphone and tablet market (have you even heard of a Dell smartphone?). The only way for these technology giants to survive is to transition into the software services market. They need to use their massive cash flows from their PC businesses to solidify their position in services.
How Dell is trying to survive
1) Belated Move into Services
Dell has realized that the only way to offset its declining PC business is by building up its software service business. IBM (IBM) had seen the signs of maturity in the hardware segment much earlier and had gotten out by selling the PC business to Lenovo. HP too has been thinking of selling its PC business to focus on software. Dell bought Perot Systems in 2009 for $3.9bb and has bought a number of smaller companies to bolster its service offerings. Some of the other notable acquisitions in the last couple of years are SaaS vendor Boomi, network and data security provider SonicWall and Quest Software. Dell has spent $13 billion in the last 4 years on acquisitions. Services contributed about ~$3bb in revenue to Dell's sales this quarter compared to the overall revenues of ~$13.8bb. The percentage of service sales is far below that of IBM, which gets ~85% of its revenues from services.
2) Cloud Computing
No decent technology company can afford not to have a strong cloud computing strategy in place. Dell has built a platform as a service based on Cloud Foundry, the open-source PaaS which operates under an Apache license. The company has also joined forces with MSFT in offering a desktop virtualization strategy for enterprises. Dell has got a massive Enterprises segment with business relationships with almost all top US private and government organizations. It can use its formidable hardware distribution to cross sell cloud computing, storage and security services.
3) The Indian Strategy
IBM has succeeded largely in transforming into a software services company by building a huge offshore development capability in India. IBM successfully copied the offshore model of software development and maintenance from Infosys (INFY) and Wipro (WIT). While Dell and HPQ also have large Indian workforces, these companies have not managed to be as successful. Now Dell is putting renewed focus in developing its Indian team by hiring the ex-CEO of Wipro - Suresh Vaswani. Mr Vaswani will directly report to Michael Dell and lead the company's IT delivery function. Mr. Vaswani has already hired his top managers from his previous employer Wipro. Given his experience and expertise, Mr Vaswani could potentially transform Dell into a world beater in software services.
To fight declining desktops sales, the WinIntel ecosystem has come out with a new product strategy - Ultrabooks. These are powerful laptops which are much thinner, lighter and faster than the traditional laptops. Some of these Ultrabooks are convertible into tablets which allow laptop users to gain the benefits of both devices for the price of one.
Other Things to Like about Dell
i) Dell starts paying Dividends
Dell has started paying a dividend in 2012 and has announced an 8c dividend for the current quarter. At the current stock price of $11, this equates to a ~3% dividend yield which is quite decent for income investors looking to invest in a solid blue chip company.
ii) Balance Sheet and Cash Flows
Dell has an excellent balance sheet despite all the pessimism about the stock. The company has almost got $2bb in net cash and is generating $1.3bb in FCF every quarter. The company has been using its large cash flows to make an entry into the services, cloud and security segments. It is also starting to return cash to shareholders like many of its technology brethren. The company has not gone overboard in acquisitions like HP ($10 billion Autonomy deal). It maintains a solid balance sheet supplemented by large operating cash flows.
Dell is as cheap as it gets for a big blue chip company with a P/E of just ~6x (based on the full year non-GAAP earnings of $1.7). The company generated $1.3bb in operating and free cash flow in the last quarter which implies that it is trading at a P/CF of less than ~4x. The company is now giving a decent dividend yield of 3%, which is now common across the WinIntel companies like MSFT, Intel (INTC) and HP.
- Management - The Dell Management has not performed well in the second half of the last decade and has had to change its CEO twice. The company has also missed out on major trends like mobile and tablets. The company has never been innovative enough spending much less on R&D than most of its peers
- Losing market share in PCs - Dell used to be the No.1 global seller of PCs; however, it has lost a massive amount of market share to upstarts like Acer and established leaders like HP and Lenovo. Dell's strategy of supply chain optimization by selling products online has been copied by competitors very easily. Dell has not come out with any breakthroughs in selling products in recent times.
Dell has been given up by investors in the last few years as the company has failed to grow due to the slowing of the PC industry. The decline in PC sales in 3Q12 has spooked the investor even more, which has resulted in Dell touching a 5-year low of ~$8.5. The stock has rebounded to $11 now, however, it remains 60% below its 5-year peak of $25. Dell due to its low valuation and ~3% yield has turned into a value stock. The market is discounting Dell's ability to become a big services player and is also not giving it enough credit for its formidable sales relationships, large and profitable enterprise segment and smart acquisitions. Dell management has been slow in recognizing the rapid changes in the technology industry like IBM. However, there are signs that Michael Dell is slowly turning around this giant technology company in the right direction. Like MSFT, we think that Dell is a good buy at these current levels as the market is not factoring in the possibility that Dell can build a large profitable services business like IBM.