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Dell and its 25% free cash flow yield


Swizzled
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I've been looking at Dell for months.

 

Started here and was confused why they weren't buying back shares more aggressively

 

http://seekingalpha.com/article/259197-dell-is-dirt-cheap-what-happened-to-the-share-repurchases

 

Not much happened to I circled back again after the started buying back shares again

 

http://seekingalpha.com/article/288019-dell-is-ripe-for-a-leveraged-buyout

 

Now I see Tilson has been buying, suggesting it could be worth 2x plus the current share price.

 

http://seekingalpha.com/article/291381-whitney-tilson-agrees-with-me-dell-is-dirt-cheap

 

Now here is my issue and what I would like input on.  This has been cheap for a long, long time.  My concern is that a catalyst never arises and eventually something does come along to kill the business.  Does anyone have any thoughts on what could get the stock price up in the next two years ?

 

I'm not unwilling to by cheap even with no catalyst on the horizon, but this one strikes me as having potential to stay cheap for an exceedingly long time.

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I've been looking at Dell for months.

 

Started here and was confused why they weren't buying back shares more aggressively

 

http://seekingalpha.com/article/259197-dell-is-dirt-cheap-what-happened-to-the-share-repurchases

 

Not much happened to I circled back again after the started buying back shares again

 

http://seekingalpha.com/article/288019-dell-is-ripe-for-a-leveraged-buyout

 

Now I see Tilson has been buying, suggesting it could be worth 2x plus the current share price.

 

http://seekingalpha.com/article/291381-whitney-tilson-agrees-with-me-dell-is-dirt-cheap

 

Now here is my issue and what I would like input on.  This has been cheap for a long, long time.  My concern is that a catalyst never arises and eventually something does come along to kill the business.  Does anyone have any thoughts on what could get the stock price up in the next two years ?

 

I'm not unwilling to by cheap even with no catalyst on the horizon, but this one strikes me as having potential to stay cheap for an exceedingly long time.

 

To some extent isn't this the same discussion that could be had with respect to any of the other old tech guard such as CSCO, MSFT, INTC, HPQ (do they still count?), etc.  They are all cheap on a quantitative basis and if the future looks anything like the past.  But there does seem to be some risk that they are all value traps at this point. 

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I'm not a fan of Dell at this point. Their business centers on providing machines for enterprise use. In the future, these machines will become less powerful on their own and will be used to access the cloud. Dell is tempting because it reminds me a little of WDC when SSDs first hit the scene and the market (and myself I might add) was confident spinning disks were obsolete. Dell still has quite a bit of life left with their current business model and may get revalued with a higher P/E, but what P/E is appropriate? I can assure you its not 15.

 

I agree with Kraven that this is the same discussion with all the old tech guard. All can be had at a fraction of their historical P/E valuations. HPQ recently announced they were going to spin off their PC division and focus on software instead. I believe this should be a warning with respect to Dell. HPQ wants to be a software/service provider, what is the most agreed upon value stock right now? (It's a software company) http://www.dataroma.com/m/home.php

 

The money is in software and services. IBM, HPQ and MSFT know it.

 

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"I'm not a fan of Dell at this point. Their business centers on providing machines for enterprise use."

 

I'm not really a fan either, but how bad does a business have to be to justify a 25% free cash flow yield ?

 

Four years and they could retire all outstanding shares.

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@ Ross:

 

And DELL doesn't know this? I disagree.

 

Imo the only difference with HPQ is that M. Dell knows there is still value in cross selling hardware with software & services and that full reliance on cloud isn't for tomorrow for enterprises. Chances are a lot of revenue is going to shift from HPQ to others like DELL because a lot of S&M businesses want both hardware & services from the same provider.

 

http://www.crn.com/news/client-devices/231600002/crn-q-a-michael-dells-take-on-hp-the-channel-and-dells-future.htm?pgno=2

 

Is Dell not shifting to software & services, away from selling hardware? Their acquisitions say otherwise. Enterprise solutions & services revenue rose 27% in 2010 including their acquisition of Perot Systems.

Are they focussed on S&S? No, 80% of their revenue still is in their product line. But 30% of their gross margin is coming from services. There is a clear shift to higher margin business, which is in services right now and I believe this trend will continue while revenue from products will stabilise further.

 

I still believe there is a lot of value in cross selling of less profitable hardware & highly profitable services for DELL. Net of net cash, which I believe hasn't been spent stupidly in the past, the PE for this company is under 5. At the current valuation this could be a PE of 4 within 18 months. I would sell out well below a PE of 15, but this company easily deserves >10 imo.

 

If I am not mistaken they have around $3-3,5b left in their share buyback program, they can buy 10-12,5% of the shares with that amount. They can and they will.

 

It is priced for failure over the long term and I just can't see that happening. To me it is irrelevant wether the stocks moves the first two years or not, this isn't a value trap (= one that loses both share & intrinsic value) and underlying business value is only going up atm, not even in decline.

 

Have no position yet, just did some back-of-the-envelope calculation some time ago and the story looks very compelling to me. When I have time I will look into it further.

 

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To some extent isn't this the same discussion that could be had with respect to any of the other old tech guard such as CSCO, MSFT, INTC, HPQ (do they still count?), etc.  They are all cheap on a quantitative basis and if the future looks anything like the past.  But there does seem to be some risk that they are all value traps at this point.

 

To some extent, perhaps.  The big differences is in the size of the moats.  No one *needs* to buy Dell for much of anything.  I would argue that people (businesses, more often) need Microsoft, and then to a lesser extent Cisco.  The other two are more similar to Dell.

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INTC might not have as strong moat as MSFT but they still have decent moat in my opinion. You can argue that people don't go and buy Intel product directly but that has been the case for a while.

 

I don't think these large caps are value trap at all. Market is very pessimistic about large tech companies at this moment and most of them are selling very cheap. Some of them have more than decent moat as well. These large cap techs are not value trap.

 

I don't hold any DELL rigth now but I think there is very good chance of making more than decent returns at current price. As far as DELL being cheap for a while argument goes then I have hard time imagining DELL selling at 2 times their FCF in few years.

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To some extent isn't this the same discussion that could be had with respect to any of the other old tech guard such as CSCO, MSFT, INTC, HPQ (do they still count?), etc.  They are all cheap on a quantitative basis and if the future looks anything like the past.  But there does seem to be some risk that they are all value traps at this point.

 

To some extent, perhaps.  The big differences is in the size of the moats.  No one *needs* to buy Dell for much of anything.  I would argue that people (businesses, more often) need Microsoft, and then to a lesser extent Cisco.  The other two are more similar to Dell.

 

INTC has a lower moat than CSCO?  ??? INTC has a very decent moat imo.

 

There is "some" moat in Dell, but do you really need it at its current valuations? How do you value the ownership management at Dell with 15% of shares owned by M. Dell? Most others lack that and that is reflected in worser acquisitions (MSFT, GOOG), serious share dilution with options (CSCO), ... Dell isn't empire building and in it for the quick buck, pursuing higher margin business as we speak.

 

With MSFT & INTC you get decent moat with reasonable upside, with DELL and maybe others (I have no opinion on them) you get a neglectable moat (probably almost none) but possibly more upside. Just my opinion of course.

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I am not willing to net out non-operating cash unless I am confident that management will do something smart with that cash.  You can net out a MSFT because management has a good history of giving money back to shareholders (buybacks, dividends and special dividends.)  I don't feel as confident about DELL\CSCO\HPQ.   

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tombgrt,

 

The assertion I am making is the PC business is not what it once was. HPQ wants to spin off their PC business because margins are contracting and they don't see a future. I'm sure Dell knows this, but they MUST ride it out because it makes up 80% of their revenues. They are trying to get into the service business, but they have a long way to go to close the gap. Right now an investment in Dell is betting they can maintain earnings by plowing cash flow into a dying business while trying to build a new profitable service business.

 

I agree that Dell is really cheap. Prem and Tilson think so too. I just don't understand investing in Dell when the other tech majors are selling at similar valuations, have a decent moat, and are not trying to reinvent themselves.

 

The main difference between HPQ and Dell is the PC business makes up 80% if Dell's revenue and only 5% of HPQs revenue. I hate the Autonomy purchase, but I was happy to see HPQ get rid of the PC business. It actually amazes me how hated HPQ is right now. The spin off of the PC business was the equivalent of Berkshire spinning off two Dairy Queens by revenue. HPQ can't make a good acquisition to save their life but they are really profitable and have a 25% free cash flow yield as well.

 

Swizzled,

 

You read Tilson's letter. I am with Tilson and am underwater in Pris/B as well. Have you taken a look at this company? The B shares pay a ~$0.98 dividend for the next 3 years before being converted into A shares. At the current share price the return is 3*.98 - (prisa/b $6.35 - prisa 5.68) = $2.27 or 35% on dividends alone. Not to mention Prisa seems to be turning the corner and on the way to becoming profitable again. Its currently selling at .44x BV.

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INTC has a lower moat than CSCO?  ??? INTC has a very decent moat imo.

 

There is "some" moat in Dell, but do you really need it at its current valuations? How do you value the ownership management at Dell with 15% of shares owned by M. Dell? Most others lack that and that is reflected in worser acquisitions (MSFT, GOOG), serious share dilution with options (CSCO), ... Dell isn't empire building and in it for the quick buck, pursuing higher margin business as we speak.

 

With MSFT & INTC you get decent moat with reasonable upside, with DELL and maybe others (I have no opinion on them) you get a neglectable moat (probably almost none) but possibly more upside. Just my opinion of course.

 

Intel's moat can be eroded very quickly if they stop (or stumble in) innovating.  They certainly have had to spend effort in fighting off threats.  MSFT--not at all.  One could argue they spent a long time coasting (or even going backwards) and they're still doing just fine.  This is not to say that MSFT is a lock, but they're going to be making money for many years yet.

 

Cisco is a bit trickier.  They have a decent moat because of the numbers of people out there who manage them who know nothing but cisco, as well as the overall installed base, but since they do not have the numbers MSFT does in terms of actual users, these could change more rapidly.  Thing is, you gain benefits from having a relatively homogeneous environment in a business, so moving from Cisco to something else has to be done in pretty large chunks, and that entails risk.

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tombgrt,

 

The assertion I am making is the PC business is not what it once was. HPQ wants to spin off their PC business because margins are contracting and they don't see a future. I'm sure Dell knows this, but they MUST ride it out because it makes up 80% of their revenues. They are trying to get into the service business, but they have a long way to go to close the gap. Right now an investment in Dell is betting they can maintain earnings by plowing cash flow into a dying business while trying to build a new profitable service business.

 

I agree that Dell is really cheap. Prem and Tilson think so too. I just don't understand investing in Dell when the other tech majors are selling at similar valuations, have a decent moat, and are not trying to reinvent themselves.

 

The main difference between HPQ and Dell is the PC business makes up 80% if Dell's revenue and only 5% of HPQs revenue. I hate the Autonomy purchase, but I was happy to see HPQ get rid of the PC business. It actually amazes me how hated HPQ is right now. The spin off of the PC business was the equivalent of Berkshire spinning off two Dairy Queens by revenue. HPQ can't make a good acquisition to save their life but they are really profitable and have a 25% free cash flow yield as well.

 

I am not sure how you calculate that the PC business makes up 80% of Dell's revenue. Here are some numbers for the last six months from Dell's last 10-Q.

 

Revenue

 

Servers & Networking $4,027

Storage $983

Services $4,020

Software & Peripherals $5,136

Mobility $9,477

Desktop PCs $7,032

Total $30,675

 

Even if you count Servers & Networking and Storage under PCs, that's 70% of revenue. But Dell sells more than just hardware in those two categories, so really only a little over 50% of revenue is from PCs. Less than half of net income is derived from PC sales. I think Dell is well on its way to transitioning away from being just a seller of PCs.

 

Also, HP had total revenue of 126 billion in 2010, of which 40.7 billion came from the Personal Systems Group. That is 32%, not 5%.

 

I own some Microsoft and Intel in addition to Dell. I agree with you that these companies have a bigger moat than does Dell, but Dell is quite a bit cheaper. TxLaw has already articulated -- in a different thread -- better than I could why a position in Dell makes sense. It seems to me that there is a substantial margin of safety at current prices.

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  • 2 weeks later...

I am not willing to net out non-operating cash unless I am confident that management will do something smart with that cash.  You can net out a MSFT because management has a good history of giving money back to shareholders (buybacks, dividends and special dividends.)  I don't feel as confident about DELL\CSCO\HPQ. 

 

That takes one argument away!  8)

 

Not that it was valid imo as they already bought back plenty of stock before. Where MSFT seems to be buying back stocks at any price, DELL seems to look at valuation first.

 

“With this additional commitment from the Board, we have the flexibility to continue making opportunistic share repurchases as a key element of our disciplined capital allocation strategy.”

 

Maybe a matter of trust in management's competence (Isn't that a requirement anyway when investing in sectors like technology?) but the numbers don't lie.

 

I have new cash coming in soon and hope I can pick some shares up at current prices as I have no cash left atm.

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I am with Tilson and am underwater in Pris/B as well. Have you taken a look at this company? The B shares pay a ~$0.98 dividend for the next 3 years before being converted into A shares. At the current share price the return is 3*.98 - (prisa/b $6.35 - prisa 5.68) = $2.27 or 35% on dividends alone. Not to mention Prisa seems to be turning the corner and on the way to becoming profitable again. Its currently selling at .44x BV.

 

I understand that the dividend is 0.175 euro per annum, not quarterly:

 

http://www.prisa.com/upload/ficheros/cuentas-anuales/2010_consolidated_annual_acounts.pdf

"From their date of issue until they are transformed into Class A ordinary shares, they pay a minimum annual dividend of EUR 0.175."

 

Am I reading that incorrectly, or did you have a different source?

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I understand that the dividend is 0.175 euro per annum, not quarterly:

 

http://www.prisa.com/upload/ficheros/cuentas-anuales/2010_consolidated_annual_acounts.pdf

"From their date of issue until they are transformed into Class A ordinary shares, they pay a minimum annual dividend of EUR 0.175."

 

Am I reading that incorrectly, or did you have a different source?

 

enoch01,

 

You are correct, the dividend is 0.175 euro per annum. The ADR available to the U.S. market represents 4 shares of pris.b. ( 4 x 0.175 x 1.4 = $0.98) Sorry for the confusion.

 

http://investing.money.msn.com/investments/stock-price?symbol=PRIS%2eB

 

 

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  • 1 month later...

Could be supply chain concerns due to flooding in Thailand.  A large percentage of the the hard drive manufacturing capacity is impacted.  Western Digital has been getting killed the last week or so as a result.  As much as half of some critical components for WDC hard drives is off line indefinitely as a result of the flooding.

 

http://seekingalpha.com/article/300739-western-digital-s-ceo-discusses-q1-2012-results-earnings-call-transcript

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On other hands, producers of hard-disk drive manufacturing equipment like XRTX, IVAC might benefit for next few quarters. XRTX will be involved in fixing stuff for WDC in Thailand but I suspect that companies will be adding capacity outside of Thailand first to add the capacity quickly. In my opinion, 35-40% of the capacity getting affected due to flooding is very huge.

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