Dell Buys Substantial Amount of DELL

[txlaw]

http://articles.moneycentral.msn.com/news/article.aspx?feed=OBR&data-ipsquote-timestamp=20101220&id=12530254

 

Given that FFH owns a substantial stake in DELL, this is pretty good news.  I also own a substantial amount of DELL, so it certainly makes me happy! 

[Ballinvarosig Investors]

I can't say I have ever understood why FFH holds Dell. When you look at where Dell is today, it's in exactly the same position it was back in 2000. In the mean time, the computer industry appears to have grown increasingly commoditized, where the lowest cost producers intensely drive down prices and margins. 11x earnings for something that isn't even growing doesn't seem cheap to me.

[Rabbitisrich]

If you include the cash hoard before the Compellent acquisition, Dell is trading at < 5x operating income.

[txlaw]

Rather than rehash the "Why does Fairfax love DELL?" debate, I would suggest doing a quick search for previous threads on the subject.

 

Here are two of the threads that I participated in:

http://cornerofberkshireandfairfax.ca/forum/index.php?topic=1042.0

http://cornerofberkshireandfairfax.ca/forum/index.php?topic=1915.0

 

The bottom line is that you have to look at the price you're paying now versus the future prospects of the company.  DELL is a considerably different company today than it was in 2000.  It's also trading at a much lower (and rationale) price for those  future prospects.

 

If you check out some of the comments made by savvy investors on this board, you will see that DELL is truly a hated company at the moment.  I can tell you that I'm betting a substantial amount of money (for me) on the notion that most people are wrong about the company.

 

Hopefully, I will not have egg on my face when all is said and done.  Wish me luck!

[Uccmal]

Every once and a while I look at Dell again but cant bring myself to hold the stock.  Indirectly I hold a couple of thousand shares through FFH so that is probably enough for now.  I expect the efforts that Dell are making into the service industry will start to pay off much as they have for IBM and others who have gone this route.  At some point the price that FFH paid for the stock will probably look cheap.  In the mean time the margin of safety is in the free cash flow. 

[DCG]

Don't forget that Michael Dell also bought a couple hundred million dollars in DELL shares when it was trading for over $20. Following him in buying shares in the past has lost people a lot of money.

 

The company produces pretty crappy computers and doesn't seem to have any idea how to regain its growth.

[txlaw]

Don't forget that Michael Dell also bought a couple hundred million dollars in DELL shares when it was trading for over $20. Following him in buying shares in the past has lost people a lot of money.

 

The company produces pretty crappy computers and doesn't seem to have any idea how to regain its growth.

 

It's not about following Michael Dell.  I try never to follow anyone into a stock if my own analysis does not confirm that the stock is indeed undervalued and mispriced.  I will admit, though, that every now and then, I will make an exception to that policy if I really trust the judgment of the person who's doing the recommending (it's still a speculative investment, though).  DELL is not one of those picks where I'm relying on anyone else's judgment.

 

I also think that the computers that Dell produces aren't that great.  In fact, I own a Macbook Pro, which I am very happy with, and I can't see myself going back to a PC anytime soon.  And certainly not to a Dell.

 

But that misses the point entirely.  Dell is a company in transformation, and people are not realizing this.  Everyone who bashes Dell is fixated on the consumer PCs, but that's not the future of the company.

[Rabbitisrich]

Right, in fact Michael Dell takes a lot of crap for being so late to the cloud and data organization party but he suffered through the 1994 experience and doesn't want to be caught in a liquidity trap again. I am not long being a tech neophyte, but Dell has a very clean, underleveraged balance sheet with plenty of room to ramp up spending where appropriate.

[frog03]

If you include the cash hoard before the Compellent acquisition, Dell is trading at < 5x operating income.

 

*****

Similar point made by Longleaf but appears wrong to me.  The cash balance is way above stockholder's equity, i.e. the cash is not belonging fully to stockholders, only partly.

[ERICOPOLY]

If you include the cash hoard before the Compellent acquisition, Dell is trading at < 5x operating income.

 

*****

Similar point made by Longleaf but appears wrong to me.  The cash balance is way above stockholder's equity, i.e. the cash is not belonging fully to stockholders, only partly.

 

Were the cash to be used for an acquisition at 20x earnings, the argument would go "poof" pretty quick.

 

And that cash hoard has been sitting there for years.  What is a dollar of cash worth today if you can't get it for 5 years?  I don't know, but I figure one should discount it.  Would I pay book value for a company that held cash only (no debt and no operations), but I was confident that it wouldn't be liquidated for 10 years?  Nope.

 

[txlaw]

If you include the cash hoard before the Compellent acquisition, Dell is trading at < 5x operating income.

 

*****

Similar point made by Longleaf but appears wrong to me.  The cash balance is way above stockholder's equity, i.e. the cash is not belonging fully to stockholders, only partly.

 

Were the cash to be used for an acquisition at 20x earnings, the argument would go "poof" pretty quick.

 

And that cash hoard has been sitting there for years.  What is a dollar of cash worth today if you can't get it for 5 years?  I don't know, but I figure one should discount it.  Would I pay book value for a company that held cash only (no debt and no operations), but I was confident that it wouldn't be liquidated for 10 years?  Nope.

 

 

When calculating Dell's excess cash, you need to make sure that you are not overstating the cash hoard due to Dell's working capital model.  You also have to consider that some of the liabilities that you would normally net out in a net cash calculation should be matched up with Dell Financial Services receivables and not included as part of any such calculation.

 

I think Dell will do a good job of allocating any excess cash that remains after they're finished with acquisitions related to the transformation. 

 

Also, in many cases paying 20x earnings (5% earnings yield) will make sense if the business lines bought will benefit from Dell's scale and distribution network. 

 

[ERICOPOLY]

Also, in many cases paying 20x earnings (5% earnings yield) will make sense if the business lines bought will benefit from Dell's scale and distribution network. 

 

I only mentioned it because I think some people who own DELL have bought it for the 5x operating income allure.  I haven't yet heard of an acquisition made at 5x earnings, so I was just pointing out that people likely aren't getting 5x earnings -- it just looks that way for now because the cash hasn't yet been deployed.

[Guest dealraker]

ERIC,

 

Well said on Dell.  I believe Dell just paid dearly for Compellent (spelling?).  They said it would be accreditive to earnings but my quick read says it was bought at 250 times this years earnings and close to 100 times expected next year estimates.  Cash spent that way?  Hmmmmm.......and old southern less-educated boy might say, "It down't go nowhere much, do it?"

 

$1 of the $13 billion out the door and nothing gained to grab hold of in my view.

 

What an industry to be in!  Your product goes down in sales price 20% a year and you have to make it up in volume?  And your famous direct model gets replaced by selling "directly" to Wal-Mart?

 

I have to admit I bought Dell at $13.  Oh well?!

[txlaw]

Yeah, the 5X earnings number (which, backs out excess cash) is not accurate.  That would be insanely cheap.

 

Regarding acquisitions, sometimes it makes sense to buy a marginally profitable company or even an unprofitable company if the company will become a very profitable company under the acquiror's control.  For example, we all knew back when FFH bought ORH that the price they paid was fair when considering ORH a stand alone company, but that it was actually worth much more in the hands of the acquiror (FFH). 

 

Or take any acquisition that Coke makes.  Coke typically has to pay a very full price for new brands, but the company is willing to do this because it knows that it can scale up the brand so that the earnings yield and ROIC for the business grows to a much better number.

 

Of course, Dell is no Coke, so if you're skeptical that they can actually make the Compellent business line a worthwhile portfolio investment, I can understand that.  But you can't just look at a static P/E ratio to determine whether an acquisition is a good one or not. 

[twacowfca]

Also, in many cases paying 20x earnings (5% earnings yield) will make sense if the business lines bought will benefit from Dell's scale and distribution network. 

 

I only mentioned it because I think some people who own DELL have bought it for the 5x operating income allure.  I haven't yet heard of an acquisition made at 5x earnings, so I was just pointing out that people likely aren't getting 5x earnings -- it just looks that way for now because the cash hasn't yet been deployed.

 

Apollo's acquisition of Brit at 5x earnings will close in a few days.  Validus bought IPC at a similar low multiple last year.

[ERICOPOLY]

Also, in many cases paying 20x earnings (5% earnings yield) will make sense if the business lines bought will benefit from Dell's scale and distribution network. 

 

I only mentioned it because I think some people who own DELL have bought it for the 5x operating income allure.  I haven't yet heard of an acquisition made at 5x earnings, so I was just pointing out that people likely aren't getting 5x earnings -- it just looks that way for now because the cash hasn't yet been deployed.

 

Apollo's acquisition of Brit at 5x earnings will close in a few days.  Validus bought IPC at a similar low multiple last year.

 

That's insurance though.  DELL isn't going to venture outside of technology one would assume.

[Rabbitisrich]

Yeah, the 5X earnings number (which, backs out excess cash) is not accurate.  That would be insanely cheap.

 

Can you run through your estimates of cash and EBIT? My estimate isn't intended to be precise:

 

I took the last 10-Q and netted $13.4B cash and short-term investments against $4.9B debt. For EBIT, I simply applied 4X to $1B, for a valuation of <5X operating income net cash before the Compellent acquisition.

 

I use the entirety of the cash position because I'm looking at it as part of a going concern and assuming the stability of the negative cash conversion at 36 days.

[txlaw]

Yeah, the 5X earnings number (which, backs out excess cash) is not accurate.  That would be insanely cheap.

 

Can you run through your estimates of cash and EBIT? My estimate isn't intended to be precise:

 

I took the last 10-Q and netted $13.4B cash and short-term investments against $4.9B debt. For EBIT, I simply applied 4X to $1B, for a valuation of <5X operating income net cash before the Compellent acquisition.

 

I use the entirety of the cash position because I'm looking at it as part of a going concern and assuming the stability of the negative cash conversion at 36 days.

 

I don't give Dell any credit for any current assets not in excess of current liabilities.  So I don't use the full cash hoard, despite the negative cash conversion cycle.  However, I do add back in DFS receivables when doing my calculaton.

 

I also give the excess cash a rather unscientific haircut based on the notion that some of the cash will need to be spent to "maintain" earnings through M&A.

 

Finally, when I say earnings, I do not use EBIT.  I come to an estimate of owner earnings that is also rather unscientific.  But conservative, I believe.

 

When all is said is done, I come out to a valuation that shows DELL being damn cheap.  But not at a 20% earnings yield.