Dell - Weak Outlook Implies Fast Erosion Of PC Business

| About: Dell Inc. (DELL)

Shares of Dell (DELL) fell up to 5% in after hours trading. The global information technology company cut its full year revenue and earnings outlook.

Second Quarter Results

Dell reported second quarter revenues of $14.5 billion, down 8% on the year. On average, analysts expected revenues to come in at $14.64 billion. GAAP operating income fell 21% to $901 million, as gross margins fell by 160 basis points to 6.2%.

GAAP earnings per share fell 13%, from $0.48 per share to $0.42 per share. Non-GAAP earnings fell by 7% to $0.50 per share, beating analysts consensus of $0.45 per share.

The enterprise division generated a 6% increase in revenues, coming in at $4.9 billion. Dell furthermore announced that it hired ex-HP networking chief Marius Haas, to push the enterprise division forward. The consumer division, reported a weak set of results. Revenues fell 22% to $2.6 billion.

Dell, which traditionally has a strong focus on laptops and personal computers, is challenged as it does not sell tablets. Furthermore it faces stiff competition on costs from companies like Acer and Lenovo, while Apple offers premium products,on the other side of the competitive spectrum.

As part of its transformation efforts, the company is on track to achieve costs savings of $2 billion in the next three years, primarily in the supply chain of the company. At the same time, it focuses on the network and enterprise division, which typically carries higher margins. Dell is using its strong financial position to strengthen its presence in the industry.

CEO and Chairman Michael Dell commented on the results, "We're transforming our business, not for a quarter or a fiscal year, but to deliver differentiated customer value for the long term. We're clear on our strategy and we're building a leading portfolio of solutions to help our customers achieve their goals."


For the third quarter of 2012, Dell expects revenues to fall 2-5% on a sequential basis. This implies revenues of $13.8-$14.2 billion. On average, analysts expected Dell to guide for revenues of $14.85 billion.

Dell continues to face headwinds from an uncertain economic environment, competitive dynamics and a soft consumer business. For the full year, it expects non-GAAP earnings of $1.70 per share. This compares to a previous forecast of $2.13 per share, and analysts expectations of $1.90 per share. The guidance includes a 2-3 cents dilutive impact from the acquisition of Quest Software.

Dell expects a weak third quarter, as distributors hold off buying new computers before the release of Windows 8, the new operating system from Microsoft, planned at the end of October.


Dell ended its second quarter with $14.6 billion in cash, equivalents and short term investments. The company operates with $9.5 billion in short and long term debt, for a net cash position of roughly $5 billion.

For the first six months of 2012, Dell generated revenues of $28.9 billion. Net income fell to $1.37 billion, or $0.77 per share. For the full year, the company is on track to report revenues of around $57 billion. Earnings are expected to come in around $2.6 billion, or $1.50 per share.

Factoring in a 5% decline in after hours trading, the market values the firm at $20 billion, or $15 billion for its operating assets. This values the firm at 0.2 times annual revenues and a mere 6 times annual earnings.

The valuation compares to a revenue multiple of 0.3 times for Hewlett-Packard (HPQ). The company trades at 8 times annual trailing earnings.

Dell announced to initiate a quarterly dividend of $0.08 per share, for an annual dividend yield of 2.7%.

Investment Thesis

Year to date, shares of Dell trade with losses of around 20%. Shares peaked around $18 in February, but fell towards $12 in today's session. In May, Dell announced a disappointing outlook for the second quarter of 2012.

Over the past five years, shares in Dell have lost roughly half their value. Sales stabilized between 2008 and 2011, but the erosion in the PC business seems to accelerate in 2012. Net profits remained stable, as Dell expanded its activities in the higher-margin enterprise business.

Investors are not too happy with Dell. Operating performance has been dismal for years, and seems to deteriorate further into 2012. The company tried to please investors by initiating a $0.08 quarterly dividend. The current dividend implies a mere $0.5 billion annual payment to shareholders vs. the company's $15 billion cash balance.

As part of its transformation strategy, the company is acquiring upcoming, but expensive companies in the enterprise industry. In 2012, it already acquire Quest for $2.4 billion. Furthermore, Dell acquired Wyse Technology, which provides cloud-computing desktop services.

Dell's PC business is eroding very fast, putting pressure on future operating performance. The network and enterprise division is not large enough to support the entire company yet. At the same time, the large investment requirements to transform the business, prevent Dell from paying more generous dividends. Also, there remains the risks that Dell might use its massive cash balances to make "expensive" acquisitions, in order to buy growth.

As I fear the value trap, I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.