John Rogers of Ariel Funds Comments on Dell
Founded in 1984 in Michael Dell's University of Texas dorm room, Dell Inc. (DELL) has grown into a leading global supplier of personal computers. For much of its history, the company differentiated itself with its unique, direct-to-consumer business model, which resulted in highly customized products, substantially lower inventory levels and impressive free cash flow characteristics. Today, that competitive advantage has largely been competed away and investors have grown fearful that a new onslaught of mobile form factors represent the demise of Dell's business. Yet, we see several reasons why this view is overly pessimistic, including the upcoming launch of Windows 8, an evolution towards enterprise solutions and the leadership of Michael Dell.
The PC is Alive and Well
The trend in computing today is towards increasing mobility. Mobile phones and tablets are no longer peripheral luxuries, but rather integral pieces to an always-on computing experience for both consumers and businesses alike. Apple, in particular, has been on the forefront of this movement, forcing its competitors to either innovate or lose share. With approximately 70% of revenues tied to personal computers, Dell has been viewed as particularly exposed to this disruptive innovation. However, whereas Apple has made tremendous inroads with the consumer, enterprises have been slow to switch, choosing instead to exercise patience for more compatible and secure Windows 8 based mobility products due out this fall. As a top global supplier of Windows-based PCs, Dell is well positioned to win where it matters most, the enterprise.
An Enterprise Makeover
Perhaps the most underappreciated piece of the Dell story has been its relatively recent transformation towards enterprise solutions and services. While investors have focused on its PC business, the company has built an enterprise solutions business that today generates approximately 30% of revenues and 50% of operating profits. Importantly, Dell has carved out its own niche by forming sticky relationships with small and medium businesses and public clients. As the mix evolves towards more solutions and services, the future for Dell looks bright.
The Return of Michael Dell
Michael Dell's tenure at Dell has been characterized by rare foresight. When he first founded the company, he saw that selling direct to the consumer would revolutionize the PC industry. When he returned to the company again in 2007, he quickly began to shift the business towards faster growing and more profitable enterprise solutions and services. Since then, operating margins have increased nearly 2%, earnings power has increased 65% and the company has accumulated a net cash balance of over $5 per share. While the evolution continues, we take comfort that a best-in-class leader is at the helm.
A Bargain Price
We view this period of transition for Dell as a tremendous buying opportunity. The drop comes amidst the company's shift from PC specialist to service and hardware provider. In our view, the current stock price assigns a low value to the enterprise solutions business, and almost no value to the PC business. As of June 30, 2012, shares traded at $12.52, a 42% discount to our estimate of intrinsic value.