- JP Morgan notes last night Dell announced that its 10-K filing would be delayed owing to its ongoing accounting investigation. While this was not entirely unexpected, the company went on to note that the audit committee's investigation had uncovered evidence of "misconduct," a number of accounting errors, and deficiencies in the company's financial control environment.
Firm believes the accounting investigation had been largely overlooked by investors, who had become increasingly focused on what Dell's restructuring plans would be. Now that the company has revealed that misconduct has occurred, firm believes the risks are more pronounced for whatever the investigation uncovers. The company has not definitively noted that a restatement will be necessary, but the company has noted the investigation is focused on revenue recognition and accruals.
- Prudential says that while the delay and language contained within the press release will be a disappointment to some investors, they think there is little risk of a delisting and/or criminal charges being brought against Dell's current executives.
They continue to recommend owning shares of Dell on our belief that there is operating leverage in the model due to 1) reduced component and operational costs, 2) a balanced pricing strategy, 3) server and storage product cycles, and 4) services expansion.
- Cowen says the main concern they have with yesterday's announcement is not the timing of when Dell will file their 10K, but what will be in the filing. They would rank the order of our concerns to be first "evidence of misconduct" then "deficiencies in the financial control", and finally just "accounting errors". For the Dell near term bulls, these comments raise the concern that historical margins that the company has enjoyed, might not be accurate. If so, the premise that the company can get close to prior margin structure might not be as important. Dell has not stated if these items will require restatement. Firm believes the company is providing information as it becomes available, but has not yet concluded its efforts.
- Merrill Lynch says their initial read is that a worst case restatement scenario appears unlikely to be consistent with the language in Dell's accounting disclosure and the outcome may be more benign than words like "misconduct" and "deficiencies" first suggest. They find it unlikely that a significant restatement would be lurking undisclosed at a point when Dell's Audit chair simultaneously asserts: (1) "as we move toward the conclusion of our investigation"; and (2) "the Audit Committee is working . . . to determine whether the accounting errors necessitate any restatements of prior period financial statements, and to assess whether the control deficiencies constitute a material weakness in Dell's internal control over financial reporting."
If Dell is near the conclusion, wouldn't it identify now if it believed a material restatement was likely? That it's still determining if "any" restatement is required suggests it may be unlikely to find a significant and obvious case at this late stage.
In firm's opinion, the key question is whether Dell's accounting errors constitute (a) earnings smoothing from quarter to quarter yet essentially accurate reporting over longer periods; or (b) outright misrepresentation of earnings power over multiple annual periods such that investors' view of historical margins is slashed.
Notablecalls: It would be easy to call not filing 10K a non-event as Prudential does, but the possible content of the filing is what makes me cautious. Concerns about the accuracy of Dell's prior margins will probably prevent any meaningful bounce in the stock today vs. current $22.90 level.