Ahead of Earnings: Why I'm Bearish on Dell

| About: Dell Inc. (DELL)
Remember Dell (NASDAQ:DELL)? What a story that was! Young, brilliant CEO, Michael Dell, revolutionizes computer assembly in much the same way Henry Ford changed automobiles. He built a computing empire that not only didn’t need retail outlets, it thrived by shunning them. Their delivery times and customization options were the thing people had wanted since PCs hit the market, and frankly, the prices were pretty darn reasonable. Customized computing to the masses through just in time and overseas assembly made Dell a giant. A lack of foresight now threatens to tear Dell apart.
Ahead of their earnings release later today, I wanted to look at Dell from a strategic standpoint, to try and figure out exactly where they are headed. They’ve made some willy nilly storage acquisitions, despite getting beat on the real gem in 3Par, and they’ve also bolstered their security arsenal. They’re looking into China, they want to be a name in enterprise IT and they’ve entered the fray of retail computing. So, do these moves reek of desperation or are they simply a strategic migration from which a sustainable, competitive company may emerge? No better time than now to take a look.
Competitive Landscape
This is an interesting thing to look at. Should we focus on their current competitors or the competitors they would like to be named in the same breath as? Right now, their competitors make computers, but in the future I think Dell would like the sentence to go, “…IBM, HP (NYSE:HPQ), Cisco (NASDAQ:CSCO) and DELL.”
Its strategies over the last few years have reflected that goal, as it has snapped up storage and security companies to try and revamp its position. The question remains, however, whether Dell is friend or foe in these transactions. Many operators in the industry have a problem with Dell, and the way that it does business. Its reputation from operating in the PC realm may be seeping into interactions with its new industry. After the Dell acquisition of ASAP Software, Tracy Butler, president of Acropolis Technology group, said:

I have never used ASAP and I wouldn't use them in the future. I wouldn't use any Dell-owned company unless I had to as an absolute last resort to meet the needs of my client…They have acted anti-channel for such a long time that saying they are embracing the channel doesn't cut it for me, nor will it ever.

So, is Dell a born again channel operator or a cash heavy company muncher? Let’s take a look at the company's acquisition history to get a better idea of where it's been and where it's headed.

Equalogic (Nov 2007) – provider of high performance storage solutions optimized for virtualization.
ASAP Software (Nov 2007) – added to Dell’s software business especially in terms of software maintenance.
Everdream (Dec 2007) – a provider of SaaS solutions for remote management, this acquisition extended their repertoire in management of servers, storage, printers, etc
The Networked Storage Company (Feb 2008) – this was a private UK firm specializing in moving clients to remote IT storage with a high profile roster of financial companies.
MessageOne (Feb 2008) – this was an email management company.
Allin (Jan 2009) – this was solely a Microsoft (NASDAQ:MSFT) expertise purchase, as Allin basically constituted four offices with 100 employees that were adept at Microsoft IT consulting
Perot Systems (Nov 2009) – Perot, their largest acquisition, was bought for $3.9 billion to boost their services unit
Kace (Feb 2010) – systems deployment and management capabilities that are catered toward midsized business IT professionals
Exanet (Feb 2010) – storage vendor Exanet develops clustered NAS technology
Scalent (Jul 2010) – provides improved virtualization capabilities to their data management
Ocarina Networks (Jul 2010) – a developer of storage compression and deduplication technology which can reduce the amount of data stored across various devices
Boomi (Nov 2010) – SaaS integration acquisition that allows transfer of data between cloud and on premise systems
Compellent (Dec 2010) – powerful and easy to use virtualization platform
Secureworks (Feb 2011) – bought to bolster Dell’s capabilities in security
After all these acquisitions, you would think Dell would be an expert. In fact, Peter Altabef, president of the company’s services division and former CEO of Perot Systems said:

We are getting in a mode now where we really do have a rhythm of how to acquire and integrate companies.

I would hope so. How do these two most recent acquisitions factor into the big picture for Dell? Peter said:

SecureWorks is a recognized industry leader in information security services and its offerings and expertise will immediately enhance our solutions portfolio.

Brad Anderson, Senior Vice President of the Enterprise Product Group at Dell said:

Compellent is a natural complement to Dell's expanding enterprise storage portfolio. The Compellent storage platform will enable Dell to provide customers additional mid- and high-end network storage solutions that simplify and reduce the cost of data management.

Most of these acquisitions coincided with the return of Michael Dell. Despite all of these, the balance sheet still looks remarkably healthy and free cash flows are more than enough to assuage any debt or liquidity concerns with acquiring these new technologies. The main gripe with this type of strategy, is the fact that assimilating technologies is not an exact science, and whether these acquisitions will create or destroy shareholder value is still very uncertain.

Although Trefis has a different take on the fair valuation, price, their models offer insight into the revenue streams of Dell. Take a look at their revenues, and you will see what I mean. Despite their string of purchases, two thirds of their revenues come from commoditized items. It will take time to build storage, even though it is experiencing great growth in that part of the business. Another opportunity is obviously tablets, but the market is so young that one bad product could ruin the company's name. I think it will be a player in the tablet market, but margins will be under downward pressure in less innovative units.

Future of Dell

Given the recent string of acquisitions, one could probably convince one's self to be optimistic about the future path of this stock. However, I believe it is too little too late for Dell in this sphere. Usually its large chest of cash would represent a competitive advantage over smaller rivals, but in this case it is going head to head with companies like HP, Cisco and IBM, which have similar loads of cash to bid on promising tech. Furthermore, these cash-laden giants already have a great name to build on, something that Dell lacks in anything other than PCs. In enterprise IT, the relationships are the currency of the business. If Dell wants to try to disrupt a successful relationship between, say, Cisco and a client, it will have to offer something compelling. I don’t think it has enough differentiators in its arsenal right now.

Additionally, if this transformation is going to succeed, Dell will have to take time and not get too greedy in its spending spree. That means taking a break if the price isn’t right, and focusing on building the synergies from previous acquisitions. I don’t believe Wall Street will allow Dell to do that. A lack of acquisitions may signal a lack of growth, and the sentiment could turn sour.


Dell is expected to earn 36 cents a share on $15.73 billion in revenue, which would be a sizeable jump from 17 cents a share on $14.9 billion last year. I am confident releasing my valuation before the earnings call, because I don’t think the long-term value of Dell relies as much on the present as it does on the future. Given the competitive landscape surrounding it in both PC and enterprise IT markets, I believe that Dell will struggle for the medium term to gain a foothold and compete. That being said, with such an incredible opportunity as the cloud forming in the tech sector, Dell is positioning itself to get a piece of that pie. A couple of prescient acquisitions could change the story, but for now I believe their PC business will hold it back from attaining its goals of higher growth. So, I am confident in giving Dell a price floor of $10 and a ceiling of $17. This is obviously pre earnings, but I see nothing on the horizon that could materially change my window of opportunity for Dell.


Insiders are pretty optimistic about this company, with an average of over three million shares being bought the last two years. Michael Dell also has almost a 12% stake in the firm, which would align the long term interests of the company with his own. However, I believe at the present time Dell is going to be hamstrung by an aging PC market.

Disclaimer: This article is to be used for educational and informational purposes only. The author holds no positions in stocks mentioned and does not plan to initiate positions within 72 hours of the posting of this article. Investments are made at your own risk and the conclusions of this article are the author’s own and do not constitute professional investment advice. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Information contained heretofore is accurate to the best of the author’s knowledge and the author expressly disclaims any liability for accidental omissions of information or errors in fact.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.