For You Believers in DELL

[Parsad]

I started this thread based on some comments by Txlaw on the Microsoft thread.  Feel free to chime in. 

In regards to DELL, I see how cheap the stock is on an enterprise level, especially based on the amount of cash in the company above and beyond what would be required for payables.  But what competitive advantages do you see with DELL?  I'm one of those guys that believes owning the software platform has more of a competitive advantage than the hardware side. 

Cheers!

[Packer16]

I think you have to look at IBM as the model of a huge tech company with moats who via buybacks and execution has provided 12% per share FCF growth over the past 5 years.  The buybacks have been on the order of 4% per year so there organic FCF growth has been about 8%.  Another aspects of moats is FCF return on working capital and fixed assets. For IBM this number is about 71%.  For this level of perfromance, IBM trades at 13x FCF.

If you compare this to MSFT you get per share FCF growth of about 9% with about 4% repurchases so you have about 5% organic growth.  MSFT's FCF return on working capital plus fixed assets is 276% (as MSFT has about $47 billion of excess cash). MSFT trades at about 6.5x FCF.

As for DELL, average FCF has declined over the past 5 years (as with many tech cos) as well as there margins.  The moat clearly is not as good as MSFTs or IBMs.  DELL's FCF return on wokring capital plus fixed assets is 184% (as DELL has about $11 billion of excess cash). This is reflected in a share price of 6x FCF.

As for CSCO, average FCF has increased over the past 5 years about 13% with about 2% repurchases so you have about 11% organic growth.  CSCO's FCF return on wokring capital plus fixed assets is 227% (as CSCO has about $38 billion of excess cash). CSCO trades at about 6.0x FCF.

From these metrics, it appears that MSFT and CSCO are better buys than DELL but all of these stocks are cheap based upon the Graham growth formula which would imply P/FCFs in the low 30s for IBM and CSCO and P/FCF of the mid 20s for MSFT.

Packer

 

[Parsad]

From these metrics, it appears that MSFT and CSCO are better buys than DELL but all of these stocks are cheap based upon the Graham growth formula which would imply P/FCFs in the low 30s for IBM and CSCO and P/FCF of the mid 20s for MSFT.

Yes Packer, I agree.  As long as they are around in ten years!     Cheers!

[Packer16]

I think IBM's example provides a good road map.  IBM has been around since the 1920s and has always been able to re-invent itself when required.  As a matter of fact, Graham mentions them as 1 of 18 industrial companies whose bonds were tested in the Depression and passed (see page 81 of 1934 edition of Security Analysis).  In addition, it generated 10 -20% returns on equity during 1930 - 1933 period. 

Packer

[shalab]

Hi Packer, your analysis is fine but it doesnt include debt when looking at cash. I would say that HPQ is cheaper and better than dell at these prices. Also, AAPL looks interesting given the iPad is still in its early phase of growth and has a good three-five years ahead of it.

[rranjan]

 As long as they are around in ten years!    Cheers!

 

Packer - IBM might have done it but I will not feel so comfortable about all companies capacity to do so.

Coming back to original question. Dell is trying to get into higher margin business.
 Dell wants to change from a selling commodity boxes into becoming a trusted enterprise solutions provider, same as with Hewlett-Packard or IBM. They want to push into data center technologies including servers and storage, which has greater switching costs and also provide consulting services.

Problem is more than two thirds of Dell's revenue remains tied to commodity hardware (desktops, laptops, peripherals). Storage represents only 4% of revenue. They want to move so badly into services that they paid high price for Perot systems. They might not be able to replicate IBM because Dell lacks the relationships and high-end hardware offerings of IBM that often helps IBM to get many services agreement.

I don't think dell has any moat. While I prefer software related moat if everything else is same but even a hardware company can have moat. For example, I think INTEL has a decent moat if not great one but I think DELL does not have any moat.

I will love if someone can make me see the moat in DELL because it is cheap right now.

[Packer16]

I agree that HPQ is cheaper than DELL and probably better also but less so when compared to CSCO or MSFT.  My FCF numbers do include interest expense so the effect debt is removed from them.  For both CSCO and MSFT the required WC capital is close to zero once cash is set eqult to 5% of sales and the debt is removed from the current liabilities.  These companies are making incredible returns on assets and the market does not believe they will continue.  I think they will continue and margin of safety comes in that they would have to fall apart to meet the market expectations.

Packer

[Munger]

While no one knows exactly what Dell will look like in 10 years, the risk/reward at these valuation levels is extremely compelling.  No predictions on where the stock price goes but downside is limited given the cash flow characteristics of the business and the fortress balance sheet, which is comforting given the risk of a major downturn in the economy.  The upside is potentially significant.  I am long the stock (and have been since $12) because of the risk/reward not because I have any great insight into what the company will be in 10 years.

For a company with a supposedly weak competitive position, Dell has generated huge free cash flow and high ROIC every year except 1 since being a public company.  Few companies have generated such consistent and robust returns during this 20+ year period, which included a collapse of the tech bubble as well as the greatest financial crisis since the Great Depression and the rise of Apple.  A key competitive advantage for Dell is the scale of its distribution network.  And Dell has unquestionably strong corporate relationships on a global basis.

Don't underestimate Michael Dell.  This consistent performance reflects his business acumen and understanding/appreciation of free cash flow and ROIC.  Michael Dell has also reached into his back pocket and pulled out $200+ million of his own money to buy stock in Dell over the past 18 months.  In addition, the company has been aggressively buying back stock at current valuation levels.  Management is on our side and has every incentive to protect and create shareholder value.  I also see Michael Dell as one of the top tech executives on the planet -- he has been immersed in the industry since he was 18 years old...I'll take him on my side any day, especially against the hapless leaders at HPQ (a company that appears to be run by the board of directors).  HPQ is a company in complete and total disarray.

The PC is far from dead.  Enterprise service and solutions now represents 30% of the top line.  The company is managed to be a cash flow machine and generate high ROIC.  Find me another company that dedicates a portion of every quarterly conference call and investor presentation discussing their efforts to continually improve asset turnover -- these guys "get it"...

I believe Dell is one of the largest positions for Southeastern/Longleaf, who own about 8% of the company and coincidently hold 8%+ (including options) of their Partners fund in Dell.  They have openly shared their thesis on the company for those interested.

[goldfinger]

Dell's ability to serve mid to small businesses or specific teams within an organization is one big part of its moat. Many IT people directly go to Dell to order their next machines and do not think twice about it (servers, laptops, appliances etc...). They can adjust their needs through Dell's web site and order. Extremely practical, it almost has become a conditioned reflex to go see what they have to offer when new hardware is needed. As far as I know this model has not been fully replicated by others. Michael Dell has complemented this offering with additional services of higher value and margins and I think that actually reinforced this area. Himself said recently that competitors cannot serve mid to small businesses as well as they do. In many cases it is still true. They invested and are investing in cloud, storage, security, software and services. They can complement their offerings with the new kinds of devices, I do not see this area as disruptive and demands for PCs and servers will continue to grow. Margins are improving, the distribution chain has gone through a recent cycle of cost cutting and optimization, I do not think it is that easy to replicate their distribution channels.
So IMHO it is a combination of brand name - good low cost hardware, low cost on demand distribution channels, completeness of the offering and customization capabilities. This has not been replicated by anyone up to now.

[goldfinger]

Longleaf Partners Fund is what you might call the Navy SEALs of the financial world -- an elite group that shuns the spotlight while performing incredible feats where others fear to tread.

How Longleaf's manager, the employee-owned Southeastern Asset Management, can handle $40 billion with such success, while receiving so little recognition, remains a mystery to me. I think they must like it this way, and I have two theories why:

1. They want to emulate the underexposed, shareholder-focused managements of the companies they love to partner with.

2. By resisting the urge to chest-thump, they gain long-term investors, as opposed to speculators lured by past performance.


Longleaf stills own Dell stock, but it's added call options to its arsenal as well, essentially levering its position. Dell call options and stock now make up 7.7% of the Partners Fund.

Any Longleaf shareholder will tell you, being contrarian is what Longleaf does best. And at least in the past, it's made them a lot of money


Audio Longleaf's Staley Cates on DELL:

http://www.longleafpartners.com/media%20files/050510-07.mp3


________________________________________________________________

Notes From Longleaf Partners' Annual Meeting

http://www.fool.com/investing/mutual-funds/2011/05/18/notes-from-longleaf-partners-annual-meeting.aspx

Ben Graham I just listen to the mp3 and I could not agree more with them. Thank you, that was a pleasure to listen to their case.