DELL INC DELL
June 01, 2009 - 2:16pm EST by
flubber926
2009 2010
Price: 12.00 EPS $1.27 $1.35
Shares Out. (in M): 1,951 P/E 9.4x 8.9x
Market Cap (in $M): 23,412 P/FCF 16.1x 11.1x
Net Debt (in $M): -7,628 EBIT 3,474 3,457
TEV ($): 31,040 TEV/EBIT 8.9x 9.0x

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Description

  

Thesis

We believe DELL is a compelling long term opportunity, with a potential return between 60-100% over the next 1 or 2 years based on our scenario and ex-cash valuations. We believe the company still holds its competitive advantages in the US, and has a great competitive position for gaining share in greater margin business as IT services.

The Business

Business Model

Direct sales model: Historically this business model was the core of DELL's moat. This enabled the company to turnover its inventories much faster than its peers and gave DELL a price advantage by eliminating indirect reseller's profits.

This business model also included a sales and marketing low-cost structure:

Sales representatives, telephone and online sales.

Mailing and e-mailing marketing publications such as catalogs and promotional publications.

Advertising in TV and print media.

When prices of PC equipment quickly deflated, DELL's efficiencies such as faster inventories turns and sales low-cost structure translated into an important cost and price advantages over its peers, giving DELL a substantial competitive moat which helped the company post one of the great growth records in the technology industry. CAGR last 22 years: Sales: 33%; Net Income: 30%; FCF: 23%.

Beside the economic impact of this business model, its direct sales allowed DELL to establish a direct relationship with its final consumers, which helped the company identify faster and more efficiently changes in the demand, consumer preferences and needs. With this advantage DELL delivered a better product with the best technology at the best prices.

This successful business model took DELL to lead the US market and to maintain this leadership untouched till today (last 7 years DELL held approximately 30% of the US computer systems market), and to report returns on capital well above its peers.

ROE

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Jan-09

DELL

81%

44%

41%

24%

44%

47%

47%

68%

62%

73%

62%

HPQ

18%

22%

5%

(4%)

7%

9%

6%

17%

19%

22%

21%

Recent history (growth stagnation). Since 2005 the company's revenue growth came to a halt, as well its FCF and profits declined. This was caused by a more competitive environment and the surge of new consumers and markets with different needs and structure.

HP emerged as a competitive player with a deep cost restructure, increasing the use of Asian outsourced manufacturers, and a wide retail distribution, suited for growth in emerging markets.

DELL's direct sales model didn't fitted for the emerging countries sales, where the growth came in the last few years.

 

Revenues

Net Income

FCF

20 years

 

 

 

DELL

33%

30%

23%

HP

13%

12%

21%

2005-2009

 

 

DELL

6%

(5%)

(28%)

HP

8%

35%

11%

Facing this environment, in 2007 Michael Dell decided to return to the company operations sifting dramatically to some new business strategies as: starting an aggressive retail distribution; and focusing on high margin business units such as servers and IT services.

Has the moat been eroded?

To answer the question: Is the moat eroded? We divided DELL's business in three segments.

1. US (Americas): Wide sustainable moat. DELL's leadership has been untouched in the last years, maintaining more than 30% of the market in the last 7 years.

This market accounts 46% of the company's revenues and 80% of the EBIT.

The revenue migration to higher margin business will benefit operations in this area.

2. Emerging markets: New strategies will give DELL competitive parity, no structural advantage. With the sales strategy shift, DELL's products can be found in more than 24,000 retail spots globally, including Best Buy, Wall-Mart, Staples, GOME, Carrefour and others.

3. IT Services: right steps to build a wide moat. In the last years DELL's diversification to businesses other than hardware has increased. In 2007 the sales of PCs and Notebooks accounted 62% of the companies net sales, while other higher margin businesses like servers, peripherals or services accounted the rest, and it is expected that in 2011 this PC and Notebook units together will represent only 48% of DELL's revenue.

While growing these businesses, DELL is trying to replicate its successful hardware sales model: establishing a direct channel with its clients that will give DELL the feedback to deliver a product that meet the needs of every individual client, and help the company to rapidly predict changes in demand and consumer preferences.

As well DELL is trying to simplify the IT services products to optimize its client's budget. Actually 70% of most companies' budget for IT ends in maintenance expense and only 30% in new initiatives. This new model of Customer-Driven Innovation seeks to reduce these costs by delivering a less complex product and a direct-individual service 

Investment Highlights

Clients: 81% of DELL's customers are commercial business all around the world and 96% of the companies in the Fortune 500 make business with DELL.

No single customer accounted for more than 10% DELL's revenues during any of the last 3 fiscal years.

In the April Morgan Stanley Survey to CIOs, DELL ranked as the first name in mind for the technology purchases of the surveyed companies for next year, placing DELL in a better position for eventual future sales than its main peers (HP-hardware and IBM-servers).

Cost restructure. The company is in the middle of a cost restructuring plan, which through a number of initiatives as headcount reductions and product cost optimization (the objective is to optimize 100% of the product portfolio vs. actual 40%) plans to reduce US $4B in costs by 2011. The original plan expected to generate savings of US $3B but the last quarter the company announced that it expects to achieve an additional US $1B. 

Share Repurchase. Only in the last 5 years the share repurchase is equivalent to de actual market cap of the company (US $21.4B). The repurchase of de last 10 years account US $34B.

Valuation. Our Ex-Cash Valuation threw an 8x P/E multiple for DELL, being one of the most compelling valuation for the industry (HPQ 12x; Acer 12x; AAPL 20.2x). 

Scenario Valuation:

 

 

 

 

2010E

 

 

 

2011E

 

US $M

2009A

 

Bull

Base

Bear

 

Bull

Base

Bear

Revenue

$61,101

 

$53,131

$50,918

$47,001

 

55,788

53,463

49,351

COGS

$49,998

 

$42,607

$40,832

$37,691

 

43,737

41,873

38,575

Gross Mgn

18%

 

20%

20%

20%

 

22%

22%

22%

Gross Inc

$11,103

 

$10,524

$10,086

$9,310

 

$12,051

$11,590

$10,776

OPEX

$7,629

 

$6,629

$6,629

$6,629

 

5,629.

5,629.

5,629.

Operating Mgn

6%

 

7%

7%

6%

 

12%

11%

10%

Operating Inc

$3,474

 

$3,895

$3,457

$2,681

 

$6,422

$5,961

$5,147

Net Mgn

4%

 

6%

5%

4%

 

10%

10%

9%

Net Inc

$2,478

 

$3,029

$2,627

$1,915

 

$5,512

$5,090

$4,342

EPS

$1.3

 

$1.6

$1.3

$1.0

 

$2.8

$2.6

$2.2

 

 

 

 

 

 

 

 

 

 

Shares Out

1,951.0

 

 

 

 

 

 

 

 

Price

$12.0

 

 

 

 

 

 

 

 

P/E

9.4x

 

7.7x

8.9x

12.2x

 

4.2x

4.6x

5.4x

 

 

 

2010E

 

 

 

2011E

 

DELL

Bull

Base

Bear

 

Bull

Base

Bear

12.0x

$18.6

$16.2

$11.8

 

$33.9

$31.3

$26.7

 

55%

35%

(2%)

 

183%

161%

123%

13.0x

$20.2

$17.5

$12.8

 

$36.7

$33.9

$28.9

 

68%

46%

6%

 

206%

183%

141%

14.0x

$21.7

$18.8

$13.7

 

$39.6

$36.5

$31.2

 

81%

57%

15%

 

230%

204%

160%

15.0x

$23.3

$20.2

$14.7

 

$42.4

$39.1

$33.4

 

94%

68%

23%

 

253%

226%

178%

16.0x

$24.8

$21.5

$15.7

 

$45.2

$41.7

$35.6

 

107%

80%

31%

 

277%

248%

197%

17.0x

$26.4

$22.9

$16.7

 

$48.0

$44.3

$37.8

 

120%

91%

39%

 

300%

270%

215%

18.0x

$27.9

$24.2

$17.7

 

$50.9

$47.0

$40.1

 

133%

102%

47%

 

324%

291%

234%

2010E:

Bull Case: Revenue -15% YOY.

Base Case: Revenues -20% YOY.            

Bear Case: Revenues -30% YOY.

The Restructuring plan is included with an OPEX and COGS total reductions of US $ 4B.

2011E: Revenue  5% YOY

Catalyst

Valuation.

Better demand outlook, revenues decreasing at slower pace than costs.

    sort by    

    Description

      

    Thesis

    We believe DELL is a compelling long term opportunity, with a potential return between 60-100% over the next 1 or 2 years based on our scenario and ex-cash valuations. We believe the company still holds its competitive advantages in the US, and has a great competitive position for gaining share in greater margin business as IT services.

    The Business

    Business Model

    Direct sales model: Historically this business model was the core of DELL's moat. This enabled the company to turnover its inventories much faster than its peers and gave DELL a price advantage by eliminating indirect reseller's profits.

    This business model also included a sales and marketing low-cost structure:

    Sales representatives, telephone and online sales.

    Mailing and e-mailing marketing publications such as catalogs and promotional publications.

    Advertising in TV and print media.

    When prices of PC equipment quickly deflated, DELL's efficiencies such as faster inventories turns and sales low-cost structure translated into an important cost and price advantages over its peers, giving DELL a substantial competitive moat which helped the company post one of the great growth records in the technology industry. CAGR last 22 years: Sales: 33%; Net Income: 30%; FCF: 23%.

    Beside the economic impact of this business model, its direct sales allowed DELL to establish a direct relationship with its final consumers, which helped the company identify faster and more efficiently changes in the demand, consumer preferences and needs. With this advantage DELL delivered a better product with the best technology at the best prices.

    This successful business model took DELL to lead the US market and to maintain this leadership untouched till today (last 7 years DELL held approximately 30% of the US computer systems market), and to report returns on capital well above its peers.

    ROE

    1999

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    Jan-09

    DELL

    81%

    44%

    41%

    24%

    44%

    47%

    47%

    68%

    62%

    73%

    62%

    HPQ

    18%

    22%

    5%

    (4%)

    7%

    9%

    6%

    17%

    19%

    22%

    21%

    Recent history (growth stagnation). Since 2005 the company's revenue growth came to a halt, as well its FCF and profits declined. This was caused by a more competitive environment and the surge of new consumers and markets with different needs and structure.

    HP emerged as a competitive player with a deep cost restructure, increasing the use of Asian outsourced manufacturers, and a wide retail distribution, suited for growth in emerging markets.

    DELL's direct sales model didn't fitted for the emerging countries sales, where the growth came in the last few years.

     

    Revenues

    Net Income

    FCF

    20 years

     

     

     

    DELL

    33%

    30%

    23%

    HP

    13%

    12%

    21%

    2005-2009

     

     

    DELL

    6%

    (5%)

    (28%)

    HP

    8%

    35%

    11%

    Facing this environment, in 2007 Michael Dell decided to return to the company operations sifting dramatically to some new business strategies as: starting an aggressive retail distribution; and focusing on high margin business units such as servers and IT services.

    Has the moat been eroded?

    To answer the question: Is the moat eroded? We divided DELL's business in three segments.

    1. US (Americas): Wide sustainable moat. DELL's leadership has been untouched in the last years, maintaining more than 30% of the market in the last 7 years.

    This market accounts 46% of the company's revenues and 80% of the EBIT.

    The revenue migration to higher margin business will benefit operations in this area.

    2. Emerging markets: New strategies will give DELL competitive parity, no structural advantage. With the sales strategy shift, DELL's products can be found in more than 24,000 retail spots globally, including Best Buy, Wall-Mart, Staples, GOME, Carrefour and others.

    3. IT Services: right steps to build a wide moat. In the last years DELL's diversification to businesses other than hardware has increased. In 2007 the sales of PCs and Notebooks accounted 62% of the companies net sales, while other higher margin businesses like servers, peripherals or services accounted the rest, and it is expected that in 2011 this PC and Notebook units together will represent only 48% of DELL's revenue.

    While growing these businesses, DELL is trying to replicate its successful hardware sales model: establishing a direct channel with its clients that will give DELL the feedback to deliver a product that meet the needs of every individual client, and help the company to rapidly predict changes in demand and consumer preferences.

    As well DELL is trying to simplify the IT services products to optimize its client's budget. Actually 70% of most companies' budget for IT ends in maintenance expense and only 30% in new initiatives. This new model of Customer-Driven Innovation seeks to reduce these costs by delivering a less complex product and a direct-individual service 

    Investment Highlights

    Clients: 81% of DELL's customers are commercial business all around the world and 96% of the companies in the Fortune 500 make business with DELL.

    No single customer accounted for more than 10% DELL's revenues during any of the last 3 fiscal years.

    In the April Morgan Stanley Survey to CIOs, DELL ranked as the first name in mind for the technology purchases of the surveyed companies for next year, placing DELL in a better position for eventual future sales than its main peers (HP-hardware and IBM-servers).

    Cost restructure. The company is in the middle of a cost restructuring plan, which through a number of initiatives as headcount reductions and product cost optimization (the objective is to optimize 100% of the product portfolio vs. actual 40%) plans to reduce US $4B in costs by 2011. The original plan expected to generate savings of US $3B but the last quarter the company announced that it expects to achieve an additional US $1B. 

    Share Repurchase. Only in the last 5 years the share repurchase is equivalent to de actual market cap of the company (US $21.4B). The repurchase of de last 10 years account US $34B.

    Valuation. Our Ex-Cash Valuation threw an 8x P/E multiple for DELL, being one of the most compelling valuation for the industry (HPQ 12x; Acer 12x; AAPL 20.2x). 

    Scenario Valuation:

     

     

     

     

    2010E

     

     

     

    2011E

     

    US $M

    2009A

     

    Bull

    Base

    Bear

     

    Bull

    Base

    Bear

    Revenue

    $61,101

     

    $53,131

    $50,918

    $47,001

     

    55,788

    53,463

    49,351

    COGS

    $49,998

     

    $42,607

    $40,832

    $37,691

     

    43,737

    41,873

    38,575

    Gross Mgn

    18%

     

    20%

    20%

    20%

     

    22%

    22%

    22%

    Gross Inc

    $11,103

     

    $10,524

    $10,086

    $9,310

     

    $12,051

    $11,590

    $10,776

    OPEX

    $7,629

     

    $6,629

    $6,629

    $6,629

     

    5,629.

    5,629.

    5,629.

    Operating Mgn

    6%

     

    7%

    7%

    6%

     

    12%

    11%

    10%

    Operating Inc

    $3,474

     

    $3,895

    $3,457

    $2,681

     

    $6,422

    $5,961

    $5,147

    Net Mgn

    4%

     

    6%

    5%

    4%

     

    10%

    10%

    9%

    Net Inc

    $2,478

     

    $3,029

    $2,627

    $1,915

     

    $5,512

    $5,090

    $4,342

    EPS

    $1.3

     

    $1.6

    $1.3

    $1.0

     

    $2.8

    $2.6

    $2.2

     

     

     

     

     

     

     

     

     

     

    Shares Out

    1,951.0

     

     

     

     

     

     

     

     

    Price

    $12.0

     

     

     

     

     

     

     

     

    P/E

    9.4x

     

    7.7x

    8.9x

    12.2x

     

    4.2x

    4.6x

    5.4x

     

     

     

    2010E

     

     

     

    2011E

     

    DELL

    Bull

    Base

    Bear

     

    Bull

    Base

    Bear

    12.0x

    $18.6

    $16.2

    $11.8

     

    $33.9

    $31.3

    $26.7

     

    55%

    35%

    (2%)

     

    183%

    161%

    123%

    13.0x

    $20.2

    $17.5

    $12.8

     

    $36.7

    $33.9

    $28.9

     

    68%

    46%

    6%

     

    206%

    183%

    141%

    14.0x

    $21.7

    $18.8

    $13.7

     

    $39.6

    $36.5

    $31.2

     

    81%

    57%

    15%

     

    230%

    204%

    160%

    15.0x

    $23.3

    $20.2

    $14.7

     

    $42.4

    $39.1

    $33.4

     

    94%

    68%

    23%

     

    253%

    226%

    178%

    16.0x

    $24.8

    $21.5

    $15.7

     

    $45.2

    $41.7

    $35.6

     

    107%

    80%

    31%

     

    277%

    248%

    197%

    17.0x

    $26.4

    $22.9

    $16.7

     

    $48.0

    $44.3

    $37.8

     

    120%

    91%

    39%

     

    300%

    270%

    215%

    18.0x

    $27.9

    $24.2

    $17.7

     

    $50.9

    $47.0

    $40.1

     

    133%

    102%

    47%

     

    324%

    291%

    234%

    2010E:

    Bull Case: Revenue -15% YOY.

    Base Case: Revenues -20% YOY.            

    Bear Case: Revenues -30% YOY.

    The Restructuring plan is included with an OPEX and COGS total reductions of US $ 4B.

    2011E: Revenue  5% YOY

    Catalyst

    Valuation.

    Better demand outlook, revenues decreasing at slower pace than costs.

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