Wednesday, March 23, 2011

Dell Looks Cheap

Dell (DELL) has seen its share of problems over the last several years. Margins declined steadily from 2005 onward (probably not coincidentally, in 2004 new management took over from the company's founder, Michael Dell) as competitors chipped away at the company's moat. But today Dell is a transformed company. Michael Dell is back at the helm, and margins have started to tick upward. However, the stock price remains at a level that would suggest a company in decline.

Dell currently trades at a P/E of 11 despite a cash balance of $14.3 billion (as of the last reporting date) that is more than half of the company's market cap. But much of this cash is stuck in international subsidiaries, and would require large repatriation taxes (though that may soon change) to use back home. Therefore, the company also carries $6 billion of debt, and plans to issue even more debt shortly. All of this adds up to a net cash position (including long-term investments, but net of acquisitions that occurred after the last reporting date) of $7.5 billion. Subtracting this net cash position from the company's market cap gives Dell a P/E of just 8.

This valuation might make sense if Dell were still a consumer PC company where competition is fierce and margins are thin. But this isn't your older sibling's Dell; last fiscal year, only $65 million of Dell's operating income of $3.4 billion came from the consumer segment. Dell now makes the bulk of its profits by selling a wide range of solutions (from storage and servers to services) to large and small business and government customers.

And Dell expects its successful initiatives in this area to continue into 2012, where the company is predicting operating income growth between 6% and 12%. How confident is Michael Dell that the company is on the right track? Confident enough that he has purchased about $150 million worth of stock in just the last week.

The road to riches for this company is not without risk, however. Dell likely won't be buying back a ton of shares, instead deploying much of its free cash flow towards acquiring firms with highly specialized technological know-how that Dell hopes to integrate into its product/service offerings. But the good news for investors is that the CEO is a business genius, and has a significant portion of his wealth invested in the company.

Paying for future growth goes against the value investing mantra. But at Dell's current price, investors don't have to. If Michael Dell can find future success with this business that is only a fraction of the past success he has had with it, shareholders at this price will reap great rewards.

Disclosure: No position


Paul said...

The guys at Longleaf are certainly bullish.

ThinQer said...

Hi, Saj,
Thanks for the analysis. I found a different perspective about the revenue source. The following article indicate DELL still relies on PC sales. This is contradictory with your comments in your article. Could you respond? Thanks!

Saj Karsan said...

Hi ThinQer,

I was talking about profits from the consumer segment. It looks like the article you cite is discussing revenues from PC sales to all segments.