Dell is a company that had quite a transformative journey over the last decade and today has a market cap of almost $40bn. I'll try to keep this post as short as possible while providing the key information that I think is relevant.
The transformation
The 2000s – Dell was the market leader, but as we all know, the PC industry was disrupted by the invention of smartphones and tablets. This had an impact on the demand for the main products that Dell was selling
2013 – Dell decided to go from public back to a private company and start its transformation
2015 – EMC acquired for $67 billion, mainly funded by debt.
2018 – Dell is back as a public company
So, we have a company that was disrupted and decided to transform and there's a good story behind it. Instead of selling certain hardware, why not provide additional solutions, become a one-stop shop and leverage the relationships with the existing customers. Of course, there was a price to pay, so looking at today's Dell, it is very different compared to Dell back in 2013.
The EMC acquisition was a huge step and comparing the purchase price ($67b) to Dell's current market cap ($40b), gives us a good insight into the significance of this transaction. This is still the largest tech acquisition to this date.
The structure
The company has two main reporting segments:
Segment #1 – Client Solutions Group (the segment that is related to the sale of hardware in the form of desktops, workstations, notebooks, and peripherals) – This segment grew from $40b in 2017 to $60b in 2021, but the majority of the growth came in 2021 (partly due to price increases).
Segment #2 – Infrastructure Solutions Group (related to the sale of storage solutions, servers, data protection, networking) – This segment hasn't experienced huge growth over the last 5 years and it went up from $30b to $35b, however, has a bit higher margin than the first one.
Last year, they also had a third segment related to VMware, but as it was divested, it doesn't add any value to make this post longer, so will skip that for now.
The debt
Being aware of the huge debt they raised back in 2015, one of the main targets of the management was to reduce it over time. In the last report (year ending January 2022), the outstanding debt was close to $27b (excluding capital leases). This amount was significantly reduced with the divestment of VMware ($38b the year before).
The dividend
Recently, the company announced that they've decided to be a dividend-paying company and the dividend yield on today's price is around 2.5%. Every time that I see this decision, I look at it as a signal/admission that the company is generating enough free cash flow after covering all of its operating expenses as well as making the debt-payments, but as they don't have a great option to invest in, it's best to return the cash back to the shareholders.
The margin
The company had $100b in revenue in the last twelve months ($5b come from VMware which is divested), with an operating margin of around 5%. However, there's almost a 2% expense on the income statement related to the amortization of goodwill. In my valuation, I am forecasting the free cash flow, so I'm adding this back as it is a non-cash movement. As for the depreciation/amortization of the assets that they need to replace over time, I'm leaving that amount in, assuming they'll need to reinvest roughly the same amount to keep the same level of business activity. Therefore, my assumption for the operating margin is 6.5% and doesn't change over time as based on the growth over time, it is fair to assume Dell is a mature company.
The revenue growth
I am assuming fairly low revenue growth (3% annually in the next 5 years, followed by a decline to the risk-free rate of 2%) which leads to revenue of $132b in 10 years.
The reinvestment
Although I've mentioned the reinvestments to maintain the same level of business activity, assuming the company grows from $95b for the last twelve months (the revenue excluding VMware) to $132b, they would need to make additional reinvestments. Historically, the Sales/capital ratio has been around 2, so I'm using the same assumption. For every $2 in revenue, I am expecting that Dell invests $1 in capital (whether that is PPE or inventory).
The outcome
With the current revenue of $100b and margin of 6.5%, the operating profit is $6.5b.
Assuming a tax rate of 25%, that goes down to almost $5b (without taking the tax impact of amortization of goodwill)
Based on the reinvestment rate, they'll be reinvesting around $1.5b per year, which leads to a free cash flow of roughly $3.5b – almost 9% of the current market cap.
I ran these assumptions through a DCF and the outcome was $76.9/share based on the risk it has.
The discount rate used was 6.7% based on WACC.
What if the revenue and operating margin assumptions change?
Below is a table that shows the fair value based on different assumptions about the future related to the revenue in 10 years from now and the operating margin:
| Revenue / Op. margin | 5.5% | 6.5% | 7.5% |
|---|---|---|---|
| 22% ($123.4b) | $60.5 | $74.9 | $89.4 |
| 31% ($132.1b) | $61.6 | $76.9 | $92.3 |
| 40% ($141.9b) | $62.7 | $79.1 | $95.5 |
| 50% ($151.7b) | $63.9 | $81.3 | $98.7 |
What you can see is that the revenue growth assumption doesn't have such a large impact on the fair value, but the operating margin has. So, if I'm to invest in Dell, I'll be more closely monitoring the change of the margin over time.
I'd like to get your feedback on this post and thank you in advance for your contribution through the comments.
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