by Paul McWilliams, editor Next Inning
The popular question of the day is, what to do about Dell
I can't suggest what any one investor should do, but I can share my
views on DELL, and why I think it is worth at least $14.75.
rumors of a private equity buyout, the price of DELL surged to hit a
high of $13.24. Then, amidst skeptical reports from pundits that still
view DELL as a PC company, the stock has sold-off today to trade in the
mid-$12s. Personally, I believe the pundits are wrong.
My view has been that the most significant problem for DELL and its
stockholders is the fact DELL executives have done a poor job
articulating the message that DELL is no longer a PC company.
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has successfully restructured its business model and should now be
viewed as an Enterprise Ecosystem company. Selling PCs is a part of this
model, but most certainly not the core of the model.
However, unfortunately for DELL and its stockholders, that clear fact has not been embraced by the analysts covering DELL.
previously presented two pieces of evidence supporting my contention
that DELL has changed its business model and should be viewed
If we go back a
dozen years to when DELL was the undisputed worldwide king of the PC
sector, DELL recognized revenue when it shipped a product and deferred
only a very modest reserve for warranty issues. As DELL moved to a more
enterprise centric business model the amount of deferred revenue
increased substantially and it is now clearly broken out in current and
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The two primary contributors to this
deferred revenue are long term service contracts and software. At the
close of the November 2, 2012 ending quarter deferred revenue totaled
just shy of $8B, or nearly 60% of DELL's reported revenue for the
Only four years ago total deferred revenue was less
than 37% of reported revenue. This is a clear indication there has been a
change in DELL's business model.
The fact that deferred revenue
has consistently grown quarter to quarter is a clear indication that
whatever has changed is probably positive.
The second piece of
evidence supporting my contention that DELL operates today with a
substantially different business model than it has in the past can be
seen in its gross profit margin profile.
During the 10 years
prior to the quarter that ended in October 2010, DELL only once reported
a gross profit margin above 20%. However, beginning with the October
2010 ending quarter DELL has consistently reported a gross profit margin
in the low to even mid-20% area.
If DELL is in fact a PC
company, like it is presented to be by the pundits, and the PC market
has been lackluster as we all know it has been, then why has DELL's
gross profit margin gone up so much? As I see it, the answer to this
question is self-evident - the pundits are wrong or at least missing
Following its report for the November 2,
2012 ending quarter, Wall Street sold off DELL with a vengeance. When we
published our last for the quarter DELL was trading at only $8.86,
which represented a valuation multiple of only 4.6 times DELL's forward
earnings plus my estimated balance sheet value of $0.75 (considerably
less than DELL's net cash value).
Based on my view of DELL, I
wrote in that report DELL's full value price was $14.75 - a 66.5%
premium to DELL's then current price. Personally, I continue to view
DELL as being worth $14.75.
While I could rationalize a higher
price based on DELL's positioning and strong cash flow that aligns well
with DELL's reported earnings, I think given the 66.5% premium from the
price last November when I assigned the full value target, that is about
what it would take to get a deal done.