For You Believers in DELL

[T-bone1]

Looks interesting, but I am not seeing any moat without some significant growth in their data center business. For me, this is a classic "I can't see where the business will be in 10 years" sort of situation. Appears cheap, but is it a value trap? Hard (for me, anyhow) to tell...

 

At 5 times cashflow, do you really need a good idea of what the business looks like in ten years?  If the cashflow is spent on buybacks and acquisitions at reasonable prices, isn't it hard to come up with a scenario where the investor loses here?

[LC]

Looks interesting, but I am not seeing any moat without some significant growth in their data center business. For me, this is a classic "I can't see where the business will be in 10 years" sort of situation. Appears cheap, but is it a value trap? Hard (for me, anyhow) to tell...

 

At 5 times cashflow, do you really need a good idea of what the business looks like in ten years?  If the cashflow is spent on buybacks and acquisitions at reasonable prices, isn't it hard to come up with a scenario where the investor loses here?

What makes you say the cash will be spent on the shareholders vs being wasted trying to innovate within a shrinking business?

[bmichaud]

"At 5 times cashflow, do you really need a good idea of what the business looks like in ten years?"

 

That is precisely how an investor falls into a "value trap", and is why Buffett got out of buying crappy businesses. If Dell's earning power is cut in half in ten years, and it's fairly valued at 10x those earnings at the end of year 9, then it is slightly overvalued here. Not saying it will happen...just saying how important the terminal value is - Sanjeev's conclusion that Dell will trade significantly higher in two or three years implicitly assumes long-run earning power is not going to erode from here, which further assumes that Dell will be able to offset price erosion on its service contracts with cost cutting (or maybe Dell has pricing power?).

[DCG]

"At 5 times cashflow, do you really need a good idea of what the business looks like in ten years?"

 

That is precisely how an investor falls into a "value trap", and is why Buffett got out of buying crappy businesses. If Dell's earning power is cut in half in ten years, and it's fairly valued at 10x those earnings at the end of year 9, then it is slightly overvalued here. Not saying it will happen...just saying how important the terminal value is - Sanjeev's conclusion that Dell will trade significantly higher in two or three years implicitly assumes long-run earning power is not going to erode from here, which further assumes that Dell will be able to offset price erosion on its service contracts with cost cutting (or maybe Dell has pricing power?).

 

True. People were saying the same type of things about RIMM's valuation..until the earnings started going away.

[ERICOPOLY]

What makes you say the cash will be spent on the shareholders vs being wasted trying to innovate within a shrinking business?

 

The shrinking business is their PC business -- so you must be talking about the PC business.

 

These past few years since Michael Dell came back...  have they been spending the money on:

a)  their PC business

b)  growing a new non-PC business model

c)  returning cash to shareholders

d)  b and c

 

My answer is "d". 

 

Do you disagree with my answer?

 

[PlanMaestro]

True. People were saying the same type of things about RIMM's valuation..until the earnings started going away.

 

That is a risk in this type of situation: management doubling down. But Dell is farther down the road and the recurrent revenue plan is working.

 

Also don't completely write-off RIMM yet: it has strengths to build on, only that it is not showing the required determination ... but that may change.

[alpha231616967560]

What makes you say the cash will be spent on the shareholders vs being wasted trying to innovate within a shrinking business?

 

The shrinking business is their PC business -- so you must be talking about the PC business.

 

These past few years since Michael Dell came back...  have they been spending the money on:

a)  their PC business

b)  growing a new non-PC business model

c)  returning cash to shareholders

d)  b and c

 

My answer is "d". 

 

Do you disagree with my answer?

 

My worry is how quickly their [commodity] pc business (80% of revenue) is declining and how slowly the new non-PC business model is growing. Services have comprised ~1% more of their revenue for each of the last three years. So I think that they are headed in the right direction, but I have little confidence that the battleship will turn quickly enough, and in the meantime SG & A is increasing (something like $1.2B increase last year) to accommodate the new strategy. How do you get comfortable with the numbers?

 

 

[enoch01]

What makes you say the cash will be spent on the shareholders vs being wasted trying to innovate within a shrinking business?

 

The shrinking business is their PC business -- so you must be talking about the PC business.

 

These past few years since Michael Dell came back...  have they been spending the money on:

a)  their PC business

b)  growing a new non-PC business model

c)  returning cash to shareholders

d)  b and c

 

My answer is "d". 

 

Do you disagree with my answer?

 

My worry is how quickly their [commodity] pc business (80% of revenue) is declining and how slowly the new non-PC business model is growing. Services have comprised ~1% more of their revenue for each of the last three years. So I think that they are headed in the right direction, but I have little confidence that the battleship will turn quickly enough, and in the meantime SG & A is increasing (something like $1.2B increase last year) to accommodate the new strategy. How do you get comfortable with the numbers?

 

A close response to that particular concern:

 

http://seekingalpha.com/article/756291-how-much-would-dell-be-worth-if-it-never-sold-another-desktop-pc

[Mephistopheles]

You can sum the non-GAAP earnings since DELL stock bottomed in Q1 2009, discount them by 50%, add them to the 2009 stock low, and that's about where the price of the stock is today. 

 

I bought some today/yesterday on the basis that it's really cheap relative to non-GAAP earnings, balance sheet is strong, management is good, it looks to be growing, they return enough to shareholders to meet my cash needs while I wait, and it seems to trade at least as high as $16 every year, including this year where it was briefly above $18.

 

 

Bought some as well, today. Do you see anything interesting with the options, ERICOPOLY?

[Parsad]

True. People were saying the same type of things about RIMM's valuation..until the earnings started going away.

 

I follow what Prem does very closely, and I've never touched RIMM.  At our AGM in April in Toronto, attendees at our AGM asked me what I thought of RIMM and at what price I would buy it...I said "Maybe 5 bucks!"  It was trading around $13.50 at the time and never got there.  I still have no real interest in investing in RIMM...they have really two businesses (hardware & services)...and both are completely intertwined with nothing in development that would allow them to grow.  Unless they do something significant at RIMM, it will eventually be a liquidation play, and five bucks is all I would pay! 

 

But DELL is not in the same position.  You have multiple lines of business growing, while their formerly core business (PC's) is deteriorating.  Still very profitable, but everyone can see clearly that the business will decline significantly going forward.  I also did the same sort of analysis as the Seeking Alpha article.  What is the worst case scenario here?  What is the company worth without that PC business?  And that is where my thinking changed, because I had not paid attention to Dell in nearly two years.  I did not notice the changes that were happening in their other businesses.  If the price keeps falling, it will be our largest position at some point...very, very cheap.  Cheers!

[MVP444300]

I agree Dell is getting very very cheap.  I hope it keeps falling so I can buy more; in fact today, when I placed the order at $10.71 my broker tried to talk me out of it by saying Dell was a dead business.    lol    Keep in mind, this was the same broker that I told me I was nuts investing in American Express at $11 and Wells Fargo at $10 in March of 2009.  I was told by a lot of my friends and family at the time what I was doing and they to thought I was insane investing in financials companies at the height of the financial crisis.

 

I don't know if you remember Sanjeev put I emailed you back channel in March of 09 asking about what you thought of American Express while the board was having discussion of Wells Fargo and you had said publicly you where investing in Wells. 

 

This same broker also tried to talk me out of investing in Nucor back in 2003 at roughly the same price I paid for Dell today (the price was higher back then but cost basis was adjusted down for 2 splits several years later) when the steal industry was in shambles with mills closing left and right.  Wilbur Ross had just started accumulating steel companies a year earlier and had started ISG if I'm not mistaken.  At the same time, Nucor had acquired Birmingham Steel at near fire sale price which I believe added a third capacity to Nucor's production.  Here you had the low cost producer of steel selling at a market cap of roughly $2.5 to $3.5 billion with a much higher earnings capacity with it recent acquisition, I thought it was a good investment but broker didn't. 

 

I'm comfortable buying Dell at these prices and I hope I can buy more at lower prices.  I will ignore the naysayers.

[Parsad]

In value investing, you do best when the "smart money" has pulled out and then the "dumb money" has also pulled out after following the smart money in too late.  Dell is getting to that point.  No one really wants to own it and even other value investors are looking bad, because you tend to come in a bit early...so they are even second-guessing themselves.  I love it when people start to throw something away.  It could very well get cheaper, and that is fine by me.  Cheers!

[Guest valueInv]

True. People were saying the same type of things about RIMM's valuation..until the earnings started going away.

But DELL is not in the same position.  You have multiple lines of business growing, while their formerly core business (PC's) is deteriorating.  Still very profitable, but everyone can see clearly that the business will decline significantly going forward.  I also did the same sort of analysis as the Seeking Alpha article.  What is the worst case scenario here?  What is the company worth without that PC business?  And that is where my thinking changed, because I had not paid attention to Dell in nearly two years.  I did not notice the changes that were happening in their other businesses.  If the price keeps falling, it will be our largest position at some point...very, very cheap.  Cheers!

Is the growth coming from acquisitions or are they organically growing? In other words, are they just buying growth?

[Parsad]

True. People were saying the same type of things about RIMM's valuation..until the earnings started going away.

But DELL is not in the same position.  You have multiple lines of business growing, while their formerly core business (PC's) is deteriorating.  Still very profitable, but everyone can see clearly that the business will decline significantly going forward.  I also did the same sort of analysis as the Seeking Alpha article.  What is the worst case scenario here?  What is the company worth without that PC business?  And that is where my thinking changed, because I had not paid attention to Dell in nearly two years.  I did not notice the changes that were happening in their other businesses.  If the price keeps falling, it will be our largest position at some point...very, very cheap.  Cheers!

Is the growth coming from acquisitions or are they organically growing? In other words, are they just buying growth?

 

Both.  As long as the return on capital over time is adequate, it doesn't matter if it's organic or purchased.  How much growth at Berkshire is acquired or organic...it's both.  CEO's should always be concerned with return on capital, not simply the legacy of their business or growing at any cost.  Cheers! 

[bathtime]

Is the growth coming from acquisitions or are they organically growing? In other words, are they just buying growth?

 

It's been mentioned in this thread, but Michael Dell talks of dropping the acquisitions into Dell's existing customer network, so the acquisitions have an expanded customer base leading to new growth. I liked M. Dell's philosophy on acquisitions - allowing those companies to maintain a certain independence (rather than merging them into the whole), while offering them access and resources to expand more quickly - which also results in better employee retention in the acquired.

[ERICOPOLY]

You can sum the non-GAAP earnings since DELL stock bottomed in Q1 2009, discount them by 50%, add them to the 2009 stock low, and that's about where the price of the stock is today. 

 

I bought some today/yesterday on the basis that it's really cheap relative to non-GAAP earnings, balance sheet is strong, management is good, it looks to be growing, they return enough to shareholders to meet my cash needs while I wait, and it seems to trade at least as high as $16 every year, including this year where it was briefly above $18.

 

 

Bought some as well, today. Do you see anything interesting with the options, ERICOPOLY?

 

No, I just own some common.

[bathtime]

A Dell engineer's blog post on Windows 8 - in repsonse to an email from Michael Dell soliciting his thoughts:

 

http://cathcam.wordpress.com/2012/06/10/windows-8-hero-or-villain/

 

Dell's reply was, "Sounds great Mark and I am seeing this in a similar way to your view below but you’ve added some new insights."

 

Forrester analyst on Dell's hiring of John Swainson to head their software group in Feb 2012:

 

http://blogs.computerworlduk.com/infrastructure-and-operations/2012/02/suddenly-dell-is-a-software-company-and-can-flourish-under-new-president-john-swainson/index.htm

 

"The next six months will tell you a lot about Swainson's impact. We expect him to make some audacious moves soon to indicate his intentions. An example would be a major acquisition. It has a good cash position as you can see in the chart. If Dell remains silent or ambivalent through this period, dump Dell. If the company does - as we expect - make some ambitious moves, Dell will be a very serious contender for your future data centre. "

 

Then in April 2012 Dell announced three acquisitions Wyse, Clerity Solutions, and Make Technologies. The engineer commented:

 

http://cathcam.wordpress.com/2012/04/06/back-to-the-future/

 

"A great set of solutions to let organizations looking to really get  their older apps into a modern execution and device environment. Exciting times for the Dell team supporting these customers.

 

This very much reminds me of 14-15 years ago and a whole slew of projects where we were trying to drive similar modernization into applications. IBM Network Station was about to be launched; we had a useful first release of the CICS Transcation Gateway and their was a great start at integrating Java with COBOL based applications and some fledgling work on extending the COBOL language to support object oriented principles. My poster session at the IBM Academy of Technology was on legacy modernization. In those days it was obvious that customers needed tools to help them get from where they’d been to where they would be going.

 

Enough never really got there, the financial case wasn’t often enough. However, given the performance, scalability and reliability of today’s x86/x64 systems, the lack of progress and demand for change have passed compelling, it’s essential."

 

Then in July he posted:

 

"Yesterday was a big day for Dell Software Group under the direction of new Senior Vice President, John Swainson, as Dell announced the acquisition of Quest Software. And in other news, I’m moving from Enterprise Systems Group at Dell, to work for VP and CTO of Dell Software Group, Don Ferguson.

 

I previously worked with Don at IBM, we overlapped in a couple of roles, in my early work on the Java connector architecture, and later in IBMs corporate On Demand initiative. We also worked together in the IBM Academy of Technology and the Systems Group Advanced e-business Council. Another former IBM colleague also emailed me this morning to confirm he had resigned and would be coming to work with us. Exciting times."

[LC]

when I placed the order at $10.71 my broker tried to talk me out of it by saying Dell was a dead business.    lol    Keep in mind, this was the same broker that I told me I was nuts investing in American Express at $11 and Wells Fargo at $10 in March of 2009. 

 

This same broker also tried to talk me out of investing in Nucor back in 2003 at roughly the same price I paid for Dell today

 

Jeeze, sounds like you may want to find a discount broker, unless you are intentionally attracting the negative criticism to test your investment thesis.

[mcliu]

How did you guys get comfortable with Dell's capital allocation skills? There doesn't seem to be much data on the IRRs for the significant past acquisitions. How do you know they will achieve reasonable returns with their large acquisitions?

 

I'm looking at Q2 and it seems like PC business revenue is falling much faster than the Enterprise business. (Is there a way to find operating income by product instead of business unit? That will add more colour to whether Enterprise can actually drive value going forward.)

[Guest valueInv]

True. People were saying the same type of things about RIMM's valuation..until the earnings started going away.

But DELL is not in the same position.  You have multiple lines of business growing, while their formerly core business (PC's) is deteriorating.  Still very profitable, but everyone can see clearly that the business will decline significantly going forward.  I also did the same sort of analysis as the Seeking Alpha article.  What is the worst case scenario here?  What is the company worth without that PC business?  And that is where my thinking changed, because I had not paid attention to Dell in nearly two years.  I did not notice the changes that were happening in their other businesses.  If the price keeps falling, it will be our largest position at some point...very, very cheap.  Cheers!

Is the growth coming from acquisitions or are they organically growing? In other words, are they just buying growth?

 

Both.  As long as the return on capital over time is adequate, it doesn't matter if it's organic or purchased.  How much growth at Berkshire is acquired or organic...it's both.  CEO's should always be concerned with return on capital, not simply the legacy of their business or growing at any cost.  Cheers!

Do you know if they are getting a return on capital on their acquisitions? Are they really growing business after integration with Dell? Any numbers?

 

You can't compare  Berkshire with Dell. Buffet does not integrate the companies he acquires, they continue to run as they were before. With Dell it's different. The only company that comes to mind that grew business by successfully integrating acquisitions is Cisco. But then, the entire company was set up to do that. Even they could not sustain that strategy. Most companies have a poor track record of successfully integrating acquisitions, especially in tech. So how does a margin of safety come from a low probability event?

[Guest valueInv]

Is the growth coming from acquisitions or are they organically growing? In other words, are they just buying growth?

 

It's been mentioned in this thread, but Michael Dell talks of dropping the acquisitions into Dell's existing customer network, so the acquisitions have an expanded customer base leading to new growth. I liked M. Dell's philosophy on acquisitions - allowing those companies to maintain a certain independence (rather than merging them into the whole), while offering them access and resources to expand more quickly - which also results in better employee retention in the acquired.

That sounds great in theory. But will it work? If they are planning to selling integrated solutions + services, they need to co-ordinate release schedules, sales, support, operations, etc. If not, they will have a hard time competing against the likes of IBM.

[bathtime]

That sounds great in theory. But will it work? If they are planning to selling integrated solutions + services, they need to co-ordinate release schedules, sales, support, operations, etc. If not, they will have a hard time competing against the likes of IBM.

 

I really don't know. I'd been looking at cheap big tech and at HPQ as a value play, Klarman continues to buy, but now that DELL has come down in price I'm finding it more interesting in risk/reward. I'm much more comfortable with management, debt position better. DELL's intentions regarding acquisitions seem a lot smarter than HPQ's continual mistakes on that front. The new software VP has top notch credentials and past successes and will be key to making these integrations work. Certainly there is uncertainty.

 

I'm also guided by a technical tool I use to time intermediate buys, which I can find helpful. It has DELL in the "accumulation zone" prior to a buy signal:

 

http://rsi.caracommunity.com/RSIApp/RSIApp.html#dell

 

 

[bathtime]

http://blogs.forrester.com/tim_sheedy/12-07-10-can_dell_be_your_strategic_vendor_in_asia_pacific

 

-----

However, I was pleasantly surprised – Dell is reinventing itself from a PC and server supplier into an IT solutions provider. The benefits of the acquisition of Perot Systems and various software assets in North America and around the globe are starting to pay dividends in Asia Pacific.

 

As a late entrant into many of the newer markets they play in, they have the rare advantage of being able to do things differently – both from a solution and a pricing standpoint. From data centre transformation through legacy migration and application modernisation, to networking solutions, Dell is attempting to be disruptive player in the market – simplifying processes that were typically human-centric, and automating capabilities to reduce the overall burden of owning and running infrastructure.

 

Their strategy is to stay close to what they know – much of their capability is linked directly to infrastructure – but their open, modular, and somewhat vendor agnostic approach is in direct opposition to the “vendor lock-in” solutions that many of the other major vendors push.

 

A key strength for Dell’s solutions business (outside of hardware) in Asia Pacific is, and will continue to be, their focus on companies below the Fortune 500– and in Japan they are starting to steal big accounts from the traditional IT services providers. Many vendors are focused on the top end of town – and spend much of their sales energies winning these clients, and their support energies keeping them happy. Dell is good at winning and supporting solutions engagements the next tier down – which represents many companies in Asia Pacific.

-------------

[boilermaker75]

If someone has already mentioned this I missed it. But FWIW, Lou Simpson has DELL in SQ Advisors,

 

http://www.sec.gov/cgi-bin/browse-edgar?company=SQ+Advisors&match=&CIK=&filenum=&State=&Country=&SIC=&owner=exclude&Find=Find+Companies&action=getcompany

[MVP444300]

I'm hoping to see Dell buyback much larger number of shares at these prices.