I wrote an article on January 1 about the "dog pound" of the tech sector and featured Dell Computer (DELL), Hewlett-Packard (HPQ), and Xerox (XRX). In the article, I mentioned that DELL would probably be an attractive takeover target because of its strong balance sheet. I pointed out that conventional analysis missed an important strength in DELL's balance sheet - the four and a half billion dollars of "financing receivables" which should really be treated as cash for net cash balance sheet analysis. It now appears that I was not the only person reading DELL's quarterly financials.
In approaching the issue of DELL's value I have used my valuation method which combines balance sheet and earnings multiple analysis and is called EPEE. EPEE is designed to simulate the private market value of a company. In the normal hurly burly of the stock market EPEE may not be relevant to the short term price action on a given stock. In the context of an LBO, it is very, very relevant. Essentially, the methodology is to back out net balance sheet cash (cash minus debt) and estimate the "enterprise price" (EP) and then calculate enterprise earnings (EE) by backing out interest income and interest expense. The result is an estimate of what a buyer is paying for the business itself. I have tweaked it recently to add or subtract the difference between depreciation and capital expenditures (CAPEX) to earnings to derive "owner cash flow" or what I call "adjusted earnings".
My December article pointed out that DELL's balance sheet is much stronger than generally appreciated because DELL consolidates the financials of Dell Financial Services and carries large amounts of its "financing receivables" as assets but that these assets are generally not treated as "cash". It should be noted that DELL also carries Dell Financial Services Debt on its balance sheet as debt and that this debt is generally included in calculating net balance sheet cash. The assets of Dell Financial Services could be sold (periodically, some of them are sold) or financed (in fact, some of DELL's debt represents a financing of these receivables) and thus have sufficient liquidity to be classified as "cash". Put more simply, if DELL sold these receivables, it would not be a wealthier company or have a stronger balance sheet, but it would have more of what is generally considered "cash".
The table below provides the relevant balance sheet entries based on DELL's most recent SEC filing.
|Total in Millions of Dollars||Per Share|
The financing receivables are not all of DELL's receivables; there is a separate balance sheet entry for receivables and, while accounts payable exceed receivables and inventory, it does not appear that DELL has distorted its entries to inflate the category of "financing receivables". The inclusion of financing receivables increases DELL's net balance sheet cash considerably and provides investors with a more accurate analysis of the company's balance sheet.
In determining DELL's adjusted enterprise earnings I have followed the methodology described above. DELL's depreciation has exceeded its CAPEX by an average of $424 million dollars over the past three full fiscal years. I added this number to earnings to produce adjusted earnings and better reflect private market value. I then subtracted interest income from adjusted earnings and added interest expense to adjusted earnings to isolate the performance of the enterprise itself. For the last full fiscal year, interest expense exceeded interest income by $198 million. Using current fully diluted share count of 1.742 billion and the lower of the last full year's earnings ($1.88) and consensus estimates for this fiscal year's earnings ($1.71), net interest expense is 11 cents per share and the excess of depreciation over CAPEX is 26 cents a share. Adding earnings to net interest expense and the excess of depreciation over CAPEX produces total adjusted enterprise earnings of $2.08 a share.
I calculate a fair private market value by using a very conservative multiple of 5 and calculating enterprise value at $10.40 a share; adding balance sheet cash of $5.55 produces a total value of $15.95 per share.
I am sure that it will be argued that I have done a certain amount of mixing and matching and I have. I have used fiscal 2012 net interest expense, and the trailing three year average to estimate the difference between depreciation and CAPEX, while I have used estimated fiscal 2013 earnings per share. I have not deducted the expense of repatriating foreign cash. There are other ways of doing these calculations and I am sure we will read a lot about them in coming weeks. But I have also used a multiple of 5 which I consider very conservative. Calculations done by others have included debt associated with the financing receivables but have not included the financing receivables as assets in calculating net balance sheet cash; this clearly understates net balance sheet cash. No matter how this is done there is a degree of judgment involved. All I can say is that, if I had the money (and unfortunately I don't), I would love to take over DELL for $15.95 a share and that anyone buying it in the $13.50 to $14.00 range is getting it very, very cheap.
An important point to understand about what is occurring is that we now have a clear demonstration that some of the unloved tech stocks have been trading well below their "private market" values. I think that this may lead investors to take another look at the sector and to begin to appreciate its potential for long term value investors.