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What are the opinions about FFH making Dell its biggest equity-position beside ORH?

 

In last 10 years the balance sheet got just more leverage, FCF didn't grow and is not very interesting compared to share price .....

 

WEB-CM

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What are the opinions about FFH making Dell its biggest equity-position beside ORH?

 

In last 10 years the balance sheet got just more leverage, FCF didn't grow and is not very interesting compared to share price .....

 

WEB-CM

 

no opinion on Dell but perhaps it could be related to the upcoming Windows7 release?

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I read a good research piece on Dell written by Murray Stahl once.  His thesis was that Dell could never grow their top line sales fast enough to offset the gradual erosion of margins.  They have an operating margin of about 5% right now, if they lose 1% percentage point here they will need to grow their sales by 20% to make up for it!

 

I guess the counterargument to this would be that they have such efficiencies of scale that at current prices their 5% margin equates to a 0% margin for all but their largest competitors. I'm not sure this is true or how you could convince Acer and Lenovo not to go after your market share without colluding.

 

The other argument against Dell I have seen lately is that the current trend is for people to buy their computer "off the rack" at Best Buy rather than customize one and have it mailed in a few days or weeks from Dell. I used to always get custom machines, but now I don't care or don't know enough when I get a new computer to bother with ordering a custom machine. I think I can get a better deal buying a "good enough" machine at a big box store. I wonder how much of any moat that Dell has is related to the custom/mail order business.

 

Either way, I am not going to second guess Hamblin Watsa, but this is definately in the "too hard" pile for me. I have a tough time thinking of another company in another industry at another time that is analogous. Maybe automobile companies at some point (durable comsumer good that everyone needs, with declining prices and improving features during industry consolidation), but this doesn't lead to much of a conclusion.

 

The company throws of a decent amount of cash and should be safe, so I'm not going to go shorting it out of my FFH position or anything like that, but I have a tough time understanding what this company looks like in "success mode", or imagining how that would come about. I would be very interested to hear a long thesis (even if it is stolen from someone else like my pessimistic take on the company)

 

T-Bone1

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I would be very interested to hear a long thesis (even if it is stolen from someone else like my pessimistic take on the company)

 

T-Bone1

 

From the Southeastern/Longleaf Conference Call October 7, 2008:

 

"So if we start with Dell.  Dell is going to report earnings of something around $1.50 and we’ll talk in a

second about the economic sensitivity of that but if they earned roughly a $1.50 of GAAP earnings per

share that would equate to $2 of real free cash earnings because most people understand their negative

working capital model and their whole kind of vaunted supply chain which creates a cash conversion

cycle that is better than the reported profits, and that means around $2 of free cash flow on a stock that

has $5 a share of net cash and no net debt.  So at today’s close of around $14 a share, an investor is

paying $9 for that $2 of free cash flow before we talk about whether that moves up or down with the

economy so that is kind of an unbelievable four and half times after tax free cash flow multiple in very

rough terms.  What is further interesting about that is that is on a profit stream whose margins are

depressed, not just down.

 

So Dell had about five years of 8% average type operating income margins and now they’re bouncing

around 5-6% so it is anything other than peak margins.  And that is also against the back drop of

management saying that they’ll get 2 billion of cost saves which would get you back to an 8% normal

operating income.  So on today’s trough margins without assuming that kind of improvement, we’re at this

four and half times real PE if you will or P-to-FCF.  And then if you look, you know if you look at what that

is comprised of, this is a company that over ¾ of that free cash flow comes from businesses and

government.  So the consumer may retrench and there may be you know competitive issues with Apple

who makes a fantastic machine and HP is coming back and all the headline stuff, but the bottom line is

businesses and governments who make up the vast majority of sales and who are usually replacing rather

than buying new machines are very unlikely to totally grind to a halt and make our free cash flow an

irrelevant number.  Looking at the product line, if you look at notebooks, the replacement value of

those, the dollar profit pool on those compared to desktops and you look at servers and stores which are

huge growth areas and very much related to internet usage.  All of those things are over 70% of their

profits.  So the desktop which seems vulnerable is a very small part of this whole puzzle.  And so this map

which is not difficult to get at or to see is fully appreciated by the company and by Michael Dell himself.  

So Michael has spent $200 million of his own money over the last six months, paying in the low 20’s to

buy personal stock, even though he already has billions of ownership which is very telling and the

company likewise has spent $1.4 billion of their cash in the last quarter repurchasing their stock.  The

$1.4 billion is just an amazing number because if you annualize that, that is over 20% of today’s market

cap that they are on pace buying their shares in.  And so you look at this and you say, is the panic right

and this stock really should be priced at 14 or is Michael and the company and any kind of rational

measure of net present value of free cash flows right and $14 is just nothing but an opportunity.  We

obviously vote the latter and continue to add as they do. "

 

I have attached the transcript.

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FWIW.........................

 

I've owned the company since 1993 and have a basis of $1.25/sh.  It's been good to me but I should have sold it in 2000 or so when it got over $60/share.  No different than Buffett saying he should have sold Coke at around the same time.  But I didn't, so I've just decided to hold on to it.

 

I think the previously stated concerns about growth and margins are likely valid.  On the other hand however, the company has no debt, $4/sh in cash and throws off nearly $2/sh in cash flow.  It's arguably a cheap stock - not as cheap as it was at 8, but cheap nevertheless.

 

In addition to FFH's recent commitment, it's also the largest holding of Longleaf/Mason Hawkins/Southeastern.  I guess my perspective today is why fight the apparent logic of Watsa and Hawkins particularly when I have such a low basis.  I have not bought anymore and won't - it's 10% of my portfolio.

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Dell has positives like its possibility to operate with negative working capital and low really necessary asset base. Therefore a good RoA is easily possible, even with the low margin business.

Additionaly the business provides continuosly FCF, but - is the valuation really attractive after the price decrease ?

 

 

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Thank's a lot Grenville. But the FCF-numbers seem to be outdated. With roughly 2 billion shares a get roughly only half the Cashflow.

 

year            05    06  07    08      09

op.CF(bln.)  5.8  4.7  3.9    3.9    1.9

 

not a pretty series!

 

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I dont know much about the working capital model but, current assets = total iabilities, so I dont see the $5 in cash on the balance sheet. The working capital may be negative but, if you shut the business down or if things slow then then it would have to be paid with real cash so I dont see the point in removing it. I dont think the 9 Billion could be paid out, so how is it excess cash.

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Guest kawikaho

Wow, awesome buy.  Too bad I was just not into investing and companies back in high school!  This would have been an all time buy!

 

FWIW.........................

 

I've owned the company since 1993 and have a basis of $1.25/sh.  It's been good to me but I should have sold it in 2000 or so when it got over $60/share.  No different than Buffett saying he should have sold Coke at around the same time.  But I didn't, so I've just decided to hold on to it.

 

I think the previously stated concerns about growth and margins are likely valid.  On the other hand however, the company has no debt, $4/sh in cash and throws off nearly $2/sh in cash flow.  It's arguably a cheap stock - not as cheap as it was at 8, but cheap nevertheless.

 

In addition to FFH's recent commitment, it's also the largest holding of Longleaf/Mason Hawkins/Southeastern.  I guess my perspective today is why fight the apparent logic of Watsa and Hawkins particularly when I have such a low basis.  I have not bought anymore and won't - it's 10% of my portfolio.

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Guest kawikaho

This is a company where I see lots of competition, little growth, and even less innovation.  I think their biggest driver is being one of the lowest cost PC and desktop computers.  They generally have a good reputation for having decent computers for business, gaming, etc...  Their laptops SUCK though.  Lenovo, and Apple have way better computers.  One area of computers that are doing well are the netbooks, and ASUS is currently owning that whole thing.  And Dell's servers are somewhat overpriced in a competitive marketplace.  There's really little innovation left for desktops and laptops.  These are companies where their time has passed, and you might make a value argument for them, but don't expect to buy and hold.  I could be wrong and Dell might have the next hot must have electronic consumer item on the horizon like Apple, but I just don't see anything at the moment.

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Regarding kawikaho's point on laptops, and also the point made earlier about people not 'preconfiguring online' as much anymore:  I think there's a pretty good correlation here.  When I used to have a desktop, all I cared for was the specs.  I mean one desktop is the same as the other, then I can get the keyboard I want, monitor I want etc.  When it comes to laptops though, I want to feel and see what I'm getting.  I'm going to be carrying it around and typing on its keyboard.  I was at the Costco the other day, trying out the dell laptop they had, and it had this tiny trackpad, and worse of all it was off center to the left.  Most people are right handed.  So it was very uncomfortable to use.  Lenovo took over IBM's laptops, and IBM used to be a typewriter company, so they generally know how to make a comfortable keyboard.  Dell's history is beige boxes as cheap as possible.  Great for the server business, not so great when a greater and greater percentage of the business become laptops.  That said, people have made the point that they are pretty darn cheap.. and who's going to argue with Watsa! :-)

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I think Dell is handicapped by the fact that prospective investors can't even think about the half of their business that isn't focused on client.

 

I think the exciting part of Dell is the Server side.  Cisco is vertically integrating.  IBM is aligning with Brocade, HP is pimping proprietary virtualization and blade technology with their own switch division and BRCM.  What is left for a company that wants open standards and low cost?

 

I think Dell is interesting, but I don't own any.  Was tempted around $10, but much was tempting then.

 

I think Dell has some opportunity in Storage and Server, and the client business can be no growth and the story here may be compelling... Michael Dell is an operator too in my eyes.

 

Ben

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Thank's a lot Grenville. But the FCF-numbers seem to be outdated. With roughly 2 billion shares a get roughly only half the Cashflow.

 

year            05    06   07     08       09

op.CF(bln.)  5.8   4.7   3.9    3.9     1.9

 

not a pretty series!

 

I dont know much about the working capital model but, current assets = total iabilities, so I dont see the $5 in cash on the balance sheet. The working capital may be negative but, if you shut the business down or if things slow then then it would have to be paid with real cash so I dont see the point in removing it. I dont think the 9 Billion could be paid out, so how is it excess cash.

 

The $1.50 figure seems to come from operating cash flow before the working cap. adjustment net of cap. ex. Then to get to $2.00, they anticipate an increase in payables to match historical figures.

 

Regarding the cash adjustment, Southeastern probably referred to cash net long-term debt. The current ratio will mislead you because Dell's receivables pay off about twice as fast as their they pay their payables, and their inventory turnover is tremendous. Just run the numbers on their cash conversion cycle to see why their balance sheet is actually stronger than it first appears.

 

 

 

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  • 3 months later...

""So if we start with Dell.  Dell is going to report earnings of something around $1.50 and we’ll talk in a

second about the economic sensitivity of that but if they earned roughly a $1.50 of GAAP earnings per

share that would equate to $2 of real free cash earnings because most people understand their negative

working capital model and their whole kind of vaunted supply chain which creates a cash conversion

cycle that is better than the reported profits"

 

Really that only works as long as the company is growing.  It is like a legal ponzi scheme.  You have extra cash because of the negative cash conversion cycle, as long as it continues to grow.  Similar to the effect of redemptions on a ponzi scheme, negative growth would result in negative cash flows from working capital.

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I am not thinking their future is going to lie in the PC to consumer business.  They do have a large presence in the business market if they can hold onto that. 

 

As an aside I bought a Compaq laptop last night for 500 Cdn with Wind 7 installed etc.  - The purchase was for my nearly 6 year old son -  The fact that it was Compaq meant nothing to me whatsoever. 

 

About 13 years ago I was in a GE Capital operation where they were assembling Dells, Compaqs, and IBM PCs side by side for retail.  Obviously this business is now in China but I expect the same thing applies. 

 

I let FFH hold this stock for me.  I am we will do well down during the next upgrade cycle. 

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Watsa, the negative working capital market doesn't require growth due to the manufacture as ordered business model. Dell might make mistakes, but their business model shouldn't produce huge cost of goods sold to payables mismatches.

 

On the other hand, doesn't it appear as if Dell is trying to grow their business through conventional strategies like design, business services, etc? This Businessweek article, http://www.businessweek.com/magazine/content/09_43/b4152036025436.htm, suggests that Dell's market cap already reflects the low cost moat.

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Guest kawikaho

Moat, what moat?  There is no moat.  Dell has so much competitors in all of its line of business, it's got nothing but low margins to sustain itself.  IBM recognized this many years ago, and decided to gear up its software side of the business.  They went on a development and acquisition spree and software has become its number one driver for growth and profits.  Forget its hardware and services side.  Hardware has become a commodity, and hence the low margins.  Many folks wrongly thought several years ago that services wouldn't be a commodity, and that it would be a large area of growth, margins, and profits, but they were wrong too.  All of the outsourcing has killed that business, and not only that, services is expensive and largely adds other overhead in terms of poor servicing.  Dell is stuck in hardware and services, both largely matured and dying commodity like businesses.  Software should be fine for the next 20 years.  I think by then, open source will become a big threat and commoditize even that.  We'll see.

 

 

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I don't own any DELL at the moment, though I'm considering purchasing some if it declines further.  We'll have to see what happens to sales going forward now that Windows 7 has come out.  I believe the company is expecting increased revenue due to a business refresh cycle, so this quarter is probably the cyclical bottom in terms of unit sales due to the delay in the new OS release date.  A lot of hardware purchases were probably delayed by businesses and consumers in anticipation of Windows 7.  DELL has increased its operating leverage through opex cuts, so if their sales bounce back, they'll generate quite a bit more owner earnings than this quarter, though that could of course be tempered by further gross margin declines. 

 

I think that margin declines are inevitable in the computer hardware business unless you're on the cutting edge like Apple.  Hardware is definitely being commoditized in the personal computing space.  I'm not so familiar with the networking hardware space, however.

 

The key to Dell's hardware business will be whether they can stem their decline in market share in the U.S. and make further progress abroad.  Unlike in the U.S., their name is not "mud" overseas, and they actually increased revenues sequentially in EMEA and Asia.  Another wild card is whether they can come out with a decent Android phone.  If they can come out with a good phone that can work on any network, who knows?  They could do very, very well both in the U.S. and abroad.

 

With respect to Perot Systems, they will need to use their salesmanship and operating expertise to increase market penetration in different sectors.  Note that they already employ quite a few people in India, so I'm not sure that the offshoring phenomenon will be a big deal for Dell long term with respect to commoditizing services.  On the contrary, they will want to try to make their services/consulting operations dovetail with their hardware operations in countries like India.

 

Back out excess cash, and you have a company that is pretty cheap given the size of the untapped market. 

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One thing I forgot to mention is that if you want to back out the excess cash in order to value the franchise, you have to make the assumption that the excess cash used to buy Perot Systems was not a value destroying acquisition. 

 

I don't think Perot Systems was that great as a stand alone company, so I'm thinking that Michael Dell will try to change that unit into a best in class company.  He may succeed.

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