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Contesting the Market Reaction to Dell Earnings

August 17, 2011 | About:
Magic Diligence

Magic Diligence

8 followers
Boy, what an awful quarter for Dell (DELL), eh?:

Dell falls 7.3% after Tuesday's weak outlook (MarketWatch)

Dell cuts guidance, shares fall (AP)

Dell Slashes Revenue Outlook, Shares Fall More Than 7% (Forbes)

Dell outlook disappoints, shares down (Reuters)

And my favorite one...

Dell Warns Of A Weak Year, Stock Drops 5% After Hours (Business Insider)

The sky is falling! IT spending is cratering! Nobody will ever buy a laptop again - tablets are taking over! Dell has no growth! This company hasn't done anything worthwhile in a decade!

But hold on... let's actually, you know, do a little (and I do mean just a little) equity research...

"Operating income for the first half of FY12 up more than 50 percent." (Dell 8-K)

"Cash flow from operations in the quarter a record $2.4 billion." (Dell 8-K, emphasis mine)

"Dell is raising its non-GAAP operating income growth expectation for FY 2012 to 17-23 percent year-over-year from 12-18 percent." (Dell 8-K, emphasis mine)

That is now 3 consecutive quarters of 7%+ operating margin for Dell, and one more at 6.7%. Just a few years ago, this was a company with 5 straight years of 5-6% margin. On a revenue base of over $60 billion, a point to 2 points of margin is huge, it can be worth up to $1.2 billion in earnings! Does anyone doubt Dell is successfully transforming its business away from the cheap desktops and crappy notebooks everyone still associates the company with? This is not a short-term phenomenon either... management was adamant on the call that these are sustainable margin improvements.

What about that revenue outlook cut, from 5-9% down to 1-5%? It is not a positive, obviously, but let's look at some components of that:

Dell is moving from reselling EMC (EMC) storage products to their own EqualLogic brand. This is contributing quite a bit to revenue weakness. But remember also that EqualLogic is far more profitable to Dell, and that business is growing at 15%. Recently acquired Compellant nearly doubled sales in Q2, after just being acquired in Q1! Once EMC comparables run off by the end of the year, the storage division (which posted a 20% sales decline this quarter) will start showing growth again.

Dell is exiting a lot of lower margin businesses where they have no angle. Examples of this include consumer electronics, re-selling of third party software, and unfavorable retail deals. Does the market really believe that Dell should stay in the business of reselling game consoles and DVD players?

Revenue weakness does not look like a long-term concern to me. The real focuses of the firm are Servers/Networking (+9% sales), Services (+6%), and Storage (just discussed). While revenue will be lost in legacy areas, these are where growth needs to come from to produce profits.

Conclusion

Dell over the years became a large, unfocused company, with their toes in all kinds of places. Under the second coming of Michael Dell, it is a firm becoming more focused, more profitable, and with more sustainable businesses. The transformation will lead to a loss of some sales, much of that voluntary. But in the end, Dell is in business to create profits for shareholders, and that is exactly what it is doing. You won't read that in the so-called mainstream business press.

Disclosure: Steve owns DELL

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Magic Diligence
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