Dell (DELL) is still valued as a PC and notebook manufacturer which means the market is missing the whole story on Dell. The reason is that the main source of value drivers for Dell is still its core PC business, netbooks and notebook computers. Based on the latest Gartner report, Dell shipped 9.8 million units in the first quarter. This is equivalent to 11% of the total 89 million global PC shipments, slightly lower by 1.6% compared to the same period last year.
Gartner cited that Dell underperformed in all of the regions. It even experienced decline in the Asia Pacific market, which was seen as a robust geographical segment for the company. Analysts at Gartner said that Dell gave low priority to the low-end consumer systems. According to them, Dell focused on investments that will build its business.
Could this be a sign that Dell is transforming into an enterprise solutions provider? In the latest quarterly filing, Dell reported full year fiscal year 2012 net income of $3.9 billion. This is an increase of 27% year on year. The robust growth is attributed to its expansion as an enterprise solutions and service provider. Revenues from enterprise solutions and services accounted for $18.6 billion, or 30% of the total revenues for the year. On the other hand, consumer business accounted for 20% of the revenues for the same period.
This is a welcome move for Dell investors. The enterprise solution business has margins of 9%. This is better than the thin margins of its consumer business at only 3%. For the last fiscal year, its operating margins have improved to 6.5%, but still lower than the industry's average of 7%. Going forward I expect that Dell margins will be higher than average operating margins of 6% as its enterprise solutions business will have higher income contribution.
Chief Executive Officer and founder Michael Dell said that its customers no longer perceive Dell as a PC company but rather a comprehensive IT solutions provider. It has invested $1 billion for its own hosting infrastructure in 10 worldwide solution centers. For the last 2 years, it has acquired companies that were related to cloud, security and data protection markets. The latest acquisition will be enterprise security software maker Quest Software.
In contrast, rival Hewlett Packard (HPQ) has decided to stick with the consumer business. HP still believes that potential of the business, which would come from streamlining its operations and producing different models and price points. The company has now increased its full year earnings outlook with expected savings for its plan to cut 27,000 jobs by the end of 2014. This gives them the flexibility if the environment weakens further.
The Little Big Blue
It is hard to imagine that Dell will compete with IBM and Intel (INTC) head on. Big Blue and Intel have the scale and large significant market share in the enterprise solutions business. I expect that Dell will move into capture the market into the smaller scale business considering that HP has decided to focus on consumer business. Since it has a strong presence in the Asia Pacific region, this is where the growth of this business will come from. Its service divisions have posted double digit growths over the last quarters while the PC and notebook businesses have contracted.
Wrongly Valued as a PC & Tablet Maker
The stock is currently trading at 6.38 times 2012 earnings. The single digit multiple valuation is attributed to declining market share and sales of its PC and notebook business. In fact, there are already reports that the PC industry is dead as Apple (AAPL) has completely disrupted the whole industry. The traditional PC and notebook market are threatened as tablets and smartphones are gaining momentum.
This is not to say that Dell will stop producing tablets and notebook computers. In fact, they can readily sell these units at their will. It would be tough as there are a lot of dominant players in this space. Dell has admitted troubles on its consumer business where PC sales are feeling increasing pressures from Apple's tablets and iPhones. The key will be to offer products at different price points as HP plans to do.
This is also the reason why the market could not reconcile the transformation of the company as a comprehensive IT solutions provider. Even if you ask a consumer, it perceives Dell as the notebook manufacturer.
A similar situation was the case of Amazon (AMZN). The market believed that it is overvalued at 40 times earnings in the early 2000's based on the peer comparators. It priced Amazon as a traditional bookstore rather than a technology company. Eventually the market correctly valued Amazon. Since then, its stock price performance has beaten the market.
It is obvious that Dell is has the same multiple valuations as laggard phone makers like Research In Motion (RIMM). Research In Motion is valued at 5 times 2012 earnings. The problem with Research In Motion is its delays in the new line of phones and poor performance of its Blackberry operating system. In contrast, Dell's problem is industry not company specific.
Even HP has a single digit valuation of 8.69 times, higher than the 5 times earnings that Dell carries. Nonetheless, it is easy to argue that Dell should not be in the same multiple bands as Research In Motion and HP as it shifts its focus to IT solutions.
The better measure will be the valuations of IBM and Intel. IBM is trading at 14 times earnings and has a dividend yield of 1.70%. On the other hand, Intel is valued at 11 times earnings. Assuming that the market could understand Dell's business, it could trade as much as $20 to $26 per share. This is double from the current levels.
It will take several quarters before the market can be convinced Dell's transformation. It still faces significant headwinds from slower corporate IT market amid the uncertainties surrounding Europe and lower government spending. Over the long run, Dell will experience the biggest gains as smaller businesses will increase the demand of the newer IT platforms.