Why I'm Investing in Michael Dell 19 comments
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Conservative Fair Value: $14
Strategy: Sell June 2009 puts with strike $10 for $.50
Result: Yield about 5% in 2 months, or buy DELL at an effective price of $9.50
Micheal Dell is back. His nitpicking, operations-heavy style is cleaning up the house that he built. Last time Dell tried to do a makeover, it attempted a run on 
ancillary products like mp3 players, printers, and the like - in an semi-failed attempt to match innovators like Apple (AAPL) (iPod) and HP (HPQ) (printers). Unfortunately those are all low margin businesses, and while some divisions have have developed scale today, they are still generally better suited for companies better-focused on those products. With start up costs high for these divisions, margins crumbled, and the stock got battered once demand for PCs started to show its cracks. Dell learned a valuable lesson: higher margin businesses are tough to replicate.
Today Dell is going through its second and third strategic directions in only a few short years. The first part is being undertaken right now as Michael Dell cut costs to improve profitability to more historic levels. Demand has fallen off the map, but Michael Dell has tried to keep pace by cutting SGA/COGS and plans of reductions of up to $4 billion in 2011. The profitability/cash flow picture will be more detailed below.
The third strategic direction is yet to be seen - but is extremely important nonetheless. Dell has apparently reached some sort of critical mass in the computer hardware business. IBM faced it by expanding into services, HP faced it by expanding into services... and it's only natural that Dell now do the same. The only question is how Dell will expand.
With $6.8 billion in net cash, some talk has been in the market that the company may make a play for a company like Accenture (ACN) or even develop its own in-house services division. However, I'm going to go the off-the-wall route and bet Dell is going to take full advantage of the "open-source" trend, pushing for better equipped open source systems that meet specific needs of business users. Remember, Dell has always been a supporter of Linux-based systems - the story goes that back in the day big, bad Microsoft (MSFT) squashed any plans Dell had to market Linux PCs.
If I were Michael Dell, I would love the opportunity to take it to big Softy and enjoy it! Now that Linux has reached some level of acceptance as most major PC manufacturers have offered a Ubuntu Linux system pre-installed, now is the time for Linux to be picked up by a major outfit to push it to the next level. Let's not forget some benefits of Linux right off the map - lower power consumption, less security threats, open source architecture,and best of all, it's cheaper since it's free!
Dell is in pristine financial shape. With $6.8 billion in net cash, Michael can decide to pursue almost any path he wishes - in house development of a services division, a buyout of a tech consulting business like Accenture, or purchase a Linux development business like Red Hat (RHT). Regardless, the $6.8 billion in net cash translates to a enterprise value of about $15 billion.
In the 4th Q, Dell made $350 million in net income. I won't bother with previous quarters' income since margins have contracted considerably since. With $4 billion in planned cuts in costs, I think the $350 million in income per quarter will be a steady one. Annualizing the $350 million and adding back depreciation/amortization of $800 million gets me to OCF of $2.2 billion.
Capex was about $450 million in 2008, and I think $500 million will be a good number for my model. PC manufacturing is extremely competitive and therefore all capex (growth and maintenance) should really be taken out of cash flows. The resulting Free Cash Flow is $2200 - $500 = $1.7 billion, or a EV to FCF ratio of less than 9x. This number should be closer to 12, giving credit to Dell's brand name and a low debt/high cash flow business model that focuses on cut-throat operations.
This business is not without some serious threats. First of all, demand can fall further. Second is the push for netbooks made by Acer and Asus, which can potentially be even more lower margin products. Third is HP's jump on the Linux OS market since it has already made its own customized consumer version of Ubuntu, called MIE - it puts them one leg up on Dell right off the bat. HP's margins come in around 7%, IBM's are at 10%, its only natural that Dell try to close the gap on their puny 2.5% margin! A margin of 5%, will make income hit $2.8 billion, and shares can be undervalued by more than 100%. Like I said earlier, higher margin businesses are tough to replicate, so here's to Dell to becoming an innovator.
Disclosure: I own Dell.
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Also, Linux isn't necessarily cheaper. Bundled software (like antivirus and media player trials) effectively subsidizes the cost of the OS.
HP MIE created a non-programmable version of Ubuntu and even made it public and they are also supporting it.. and its a consumer version that uses more graphics/entertainment apps that would probably require more specific updates/modifications than would a stripped-down corporate version would likely require.
HPs MIE 1000 laptop also came in at $50 or $100 cheaper (i forget) than the Windows version.
What utter nonsense, just making up junk to support your viewpoint.
""""HPs MIE 1000 laptop also came in at $50 or $100 cheaper (i forget) than the Windows version""""
complete bolloxs there is a $20 diff and no one is buying the linux one.
goto HP and check, it takes the same amount of time as it does to write this sentence.
Smoking crack is very bad for you.
In the short-run Economies of Scale will create larger margins, which Dell enjoyed once upon a time. But in the long-run Returns to Scale will squeeze those once coveted margins to razor thin levels which Dell is currently faced with. How much lower can margins go and still be considered a viable business model?
Here is my question to you that I ask all my students: Where does Dell go from here?
I have yet to get a reasonable response. Thus my short in Dell and subsequent 100% ROI.
There is a special place in hell for Michael Dell allowing his company to become this way.
i agree but a lot of that is past looking -
dont forget how $7 billion in net cash can change the picture of a company.. and change it fast - the same things we are arguing about now with Dell happened with IBM, HPQ, Emachines, Gateway, and every other major mainstream hardware supplier
pure rubbish talk. $7billion is PART of the picture already, it cant change anything.
If you were talking about a magic $7billion that say Gates just gifted to dell for free and grossed up the tax, then sure that would change the picture.
But existing cash is part of the current picture. Sure they have money to invest, if they didnt they would be worth less.
With respect, I completely disagree.
While cash "helps to calm the nerves", to borrow a time honored French expression, without fundamental management/structural change the cash will find its way somewhere and be of no real benefit in the end.
There are a lot of former Dell customers out there because of their problems. I do not think that is backward looking. Without change it is forward looking. The past IS prologue to the future.
Dell's original business plan was to enter markets that were in the process of being comoditized and "work the (profit) margins". It has become one where they "make up the losses in volume" to borrow a tired joke. Competition need not be a suicide pact.
On Apr 28 11:22 PM Violent Capitalist wrote:
> infinite and dell is hell,
>
> i agree but a lot of that is past looking -
>
> dont forget how $7 billion in net cash can change the picture of
> a company.. and change it fast - the same things we are arguing about
> now with Dell happened with IBM, HPQ, Emachines, Gateway, and every
> other major mainstream hardware supplier
What is this .... a evening cake walk where MaDell can come in the beginning and then take a back seat and then come back again to do the 'steve jobs' type of stuff ?
Today it is a race, if you are left behind not only your competition will zoom ahead, they will make sure that you never come close to them.
Numbers on the side --- What product, What service, What value Dell has today (and even had in last 2 years) to provide to customers ? Why are customers leaving and not coming back to Dell ? I am just questioning the basic fundamentals over here i see missing in Dell.
But, truth be told, we haven't seen any sign of DELL actually doing anything useful with all that cash, have we?
I would rather invest in Dell when they announce a strategy for using their cash that I consider to be a suitable one, rather than on the expectation that they may one day come up with a strategy that I may or may not like.
everyone knows they HAVE to use the cash somehow, even if they don't pull the trigger - stakeholders will inevitably make cause for an acquisition (employee defects, shareholder activism, analyst reports, etc)
businessweek, barrons, wsj, and others are all writing about it now as Dell ponders which acquisition to make. Look for a deal to happen within the next year.
www.reuters.com/articl...