For years Dell (DELL) has been stuck in the shadows of its larger rival, HP (HPQ). But as HP stumbles from crisis to crisis, Dell has been humming along, slowly but surely transforming itself from a commodity PC vendor to a tech hub. In this article, we will profile Dell and allow readers to determine if Dell is the right stock for them.
Dell, named after its founder and current CEO Michael Dell, sells computers and other technology products across the world. For years the company has toiled in the shadows of HP. But this year HP has shown remarkable incompetence, resulting in a devastating drop in the stock price of one of America's blue chip companies.
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HP has lost nearly half its value over the past year, while Dell has posted a gain of nearly 16%. Because Dell and HP are competitors in so many markets, they are exposed to the same macro-economic forces, so if one suffers more than another, they cannot blame it on macro-economic conditions. HP has failed to execute in almost every business it is in and, as a result, the shares are valued at an all time low P/E. However, companies with low P/E ratios are often valued there for a reason, RIM (RIMM) being a prime example. We are not considering HP because there is just far too much uncertainty there, with the exorbitantly overpriced acquisition of Autonomy and the appointment of Meg Whitman as CEO.
Dell, however, has many attributes that set it apart from HP, making it appealing for some investors to consider. Dell has been diversifying away from the PC business but in a controlled manner, unlike HP, which simply announced it will be looking how to exit the business. Dell acknowledges that its consumer business is weak, with Brian Gladden, Dell's CFO, openly stating that "consumer revenue was up 1% to $2.9 billion, driven by strong growth in EMEA and APJ, whereas Americas revenue declined."
Dell does not hide the fact that its PC business is withering in the face of Apple's (AAPL) transformative products. And Apple's results show that the problem is not with personal computers. The problem lies with non-Apple computers. Dell realizes this and its revenue base has been diversified to address these challenges. Dell, like Oracle (ORCL) has traded revenue for profitability, with its CFO stating that "as part of our strategy, we continue to make deliberate decisions to eliminate low value-added [products with low profitability] from the portfolio." Dell has showed discipline in improving margins and profitability.
A counter-point to this is that Dell must invest aggressively and acquire companies if it is to fend off the endemic threats to its PC business. Credit Suisse, for instance, notes that Dell's expenses will have to grow at a time when headwinds threaten the company. It fears that margins have peaked. We do note these concerns, but would like to point out to potential Dell investors that this is a long-term story, and Dell must atone for the sin of being in the PC business by paying to grow faster in other sectors.
But at least Dell is doing something about the problems it faces. HP has done nothing to solve the structural challenges facing the company. Dell now receives half of its revenues outside the US, and although the shift from reselling products from vendors such as EMC (EMC) to selling its own wares will cause short-term sales declines, it is important to note that even though Dell has cut its revenue outlook for this fiscal year from 5-9% down to 1-5%, it has raised its operating income growth expectations to 17-23%, from 12-18%.
Finally, Dell has one more appealing feature, and it is one that HP can only dream of. Dell has a pristine balance sheet, with $8.4 billion in net cash, which makes up nearly 32% of its market capitalization. HP, on the other hand, has nearly $13 billion in net debt.
Dell has shown an eagerness to use this cash to acquire companies necessary for its transformation. And, unlike HP, it has a far better track record of paying the correct price for an acquisition. In addition, Dell has also been buying back shares.
In conclusion, we think Dell can be a good value play for investors willing to wait it out as Dell slowly but surely diversifies away from the PC business. We will be blunt and say that investors looking for growth and peace of mind can go elsewhere, to companies such as Apple and EMC, both of which we own.
Given our more aggressive growth-oriented approach, Dell's turnaround story is too slow for us. However, Dell is tremendously undervalued, given that nearly a third of its market capitalization is in cash. For investors willing to wait it out as Dell turns itself around, this company could very well be a worthwhile investment.
Disclosure: I am long EMC, AAPL.
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