While we were pleased that Dell (DELL) decided to suck it up, admit its age and begin paying dividends to shareholders, we don't believe that should distract investors from the fact that Dell is disappearing into irrelevance. We see that despite spending over $5B in acquisitions over the last 18 months, Dell's revenue continues to crumble like a cookie (down 6% year-over-year in H1 2013 versus the prior year period). Unfortunately, Dell's revenue declines are leading to profit declines and that is leaving a sour taste in the mouths of Dell's stakeholders.
Corporate and Business Highlights and Lowlights
As we mentioned, Dell's revenue in H1 2013 declined by 6% versus H1 2012 and its Q2 2013 revenue declined by 8% versus the prior year's period. While the company had partially offset the revenue decline with cuts in the cost of products and services sold as well as operating and administrative expenses, the cuts were not enough to offset the revenue declines and Dell had a 21% operating income decline in Q3 2013 versus the Q3 2012 period. Dell's H1 2013 operating income declined by 27% and because of a 7% reduction in outstanding shares year-over-year, the company's H1 EPS only declined by 20%. Dell saw a 1-22% year-over-year revenue decline in Q2 2013 in all four of its Global Client Reporting Segments (Large Enterprise, Public Sector, Small and Mid-Size Business and Consumer) and four of its Product Category Segments (Storage, Software and Peripherals, Mobility and Desktop PCs) saw year-over year revenue declines in the quarter. Dell's Servers and Networking and Services businesses saw 14% and 3% year-over-year revenue increases due to acquisitions. The only customer reporting segment at Dell that saw a Q2 2013 increase in its operating income was the Small and Mid-Size Business segment with an eye-popping 0.5% year-over-year growth. The rest of the segments saw operating income decline from 6% to 86.4% year-over-year
Source: Dell's Q2 2013 Earnings Release
We're not sure which is worse - Dell's performance or Dell's forward outlook. It's bad enough that it saw 6% revenue decline for H1 2013 versus the prior year's comparable period even with the aid of $5B in acquisitions in the last 18 months and that was compounded by the fact that Dell is expecting its revenues to decline by 2-5% on a linked-quarter basis. Dell's implied revenue guidance for Q3 is $13.8B-$14.2B and Dell reduced its FY 2013 EPS estimate by $0.03 to $1.70 in order to account for the pending acquisition of Qwest Software. This compared negatively to the $2.13 earned last year and the $1.94 that analysts were previously forecasting. Analysts also cut their estimates for FY 2014 to $1.92 recently from the $2.07 over the last 90 days.
Source: Morningstar Direct and Dell's Q2 Conference Call
Corporate Asset Management & Valuation
While we are happy to see that Dell reduced its CapEx budget by nearly 12% for H1 2013 versus H1 2012 as well as its payment of $570M in outstanding debt and its willingness to initiate a dividend beginning in Q3 2012, we are displeased with its acquisition spree. We're wondering if Dell thinks it can restore its youthful vigor of the 1980s and 1990s by acquiring smaller tech firms. We like that Dell initiated a dividend for Q3 2013 and it increased the amount of annual free cash flows distributed to shareholders from 20% to 35%. Unfortunately, Dell includes "strategic investments (AKA acquisitions)" as part of that 20%-35%. The good news for Dell is that its outstanding share count has declined from 2.644B shares in 2003 to 1.753B shares in Q2 2013. Unfortunately, Dell's average cost to repurchase shares was around $25.25, based on the $22B spent on repurchases over the last 10+ years to reduce 891M net diluted shares outstanding, which compares unfavorably with the $10.83 price that Dell's shares were trading at on Friday September 21st.
Source: Morningstar Direct
In conclusion, we are not fans of the traditional personal computer segment and we believe that Dell and Hewlett-Packard (HPQ) will continue to struggle. We would avoid, sell, or buy a put on Dell shares for our book. In our professional opinion we have more optimism in H-P turning itself around than Dell since we expect more from Meg Whitman and her team than Michael Dell and his team. However we are expecting both companies to struggle due to the declining demand for traditional PC computers. The good news about investing in Dell is that it pays a dividend and has realized that it has gotten a bit long in the tooth. The bad news is that it thinks it can grow its way back to the top via acquisitions. The ugly news is that while it is increasing the amount of annual free cash flows distributed to shareholders from 20% to 35%, it includes "strategic investments (AKA acquisitions)" as part of that 20%-35%. We are still shocked though at how Dell has fallen from grace. We remember that it was held up as a case study of a successful company in business schools worldwide. Now, it is being held up as an example of a company that lost its way. We noticed that Dell does not issue pro forma financial results that show the results of the combined company assuming the acquisition took place at the beginning of the year. It's a good thing that it doesn't because we expect the results to be worse that what it reported. Not including this pro forma adjustment assuming the acquisitions took place at the beginning of the year is probably the one reason why we miss pooling-of-interests accounting because we believe that method of accounting had a valid use in that we could see how the combined enterprise would have performed at the beginning of the period assuming it combined then.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.