Executive Summary:

Dell has stable long-term prospects. They are a mature company. If they can tame their balance sheet, they would likely significantly increase their share price through returns to shareholders. Another possibility is that they try to become private again because Michael Dell only took the company public to finance an acquisition. They are currently trading at a significant margin of safety between 11% (no growth) and 44% (10% growth).

Introduction:

Dell provides businesses with IT solutions, ranging from traditional infrastructure, cloud infrastructure, hardware, and software. They also provide consultant-like solutions such as management and migratory support. They also have consumer-oriented businesses that offer off the shelf and custom to order PC’s. About half of their revenue is generated in the Americas. They have made a number of large acquisitions, notably EMC (cloud infrastructure/solutions), SecureWorks (IT security), and Virtuestream(Cloud ops). They have operations in 180 countries.

The business is organized into two operating segments, Infrastructure Solutions Group, and Client Solutions Group.

History:

Dell was founded by Michael Dell in 1984. They produce cell phones, computers, other hardware, and software, but used to do “build to order” enterprise infrastructure, which was especially popular in the internet bubble. Its two divisions are Dell client solutions group (CSG), and Dell infrastructure solutions group (EMC). Dell acquired EMC in 2015 for $67 billion, diversifying into the enterprise software and store industry. They bought Alienware in 2006. The company has traditionally been involved in the enterprise hardware business, specifically developing custom infrastructure. They have a focus on high performance PC’s and custom PC’s. If anything can be taken from their corporate history, it is that the company is not afraid to take dramatic actions to save its skin.

By the late 2000’s the company could not turn profits in the “make to order” business. They decided to shift towards off the shelf consumer and enterprise solutions. They were taken private in 2013 and went public again in 2018. VMWare was owned by EMC, and thus came under the control of Dell. Dell has decided to spin off VMWare, and there is a pending acquisition by Broadcom. The VMWare spinoff was completed in 2021. Michael Dell has been chairman since 1984, and apart from 2004-2007, has been CEO of the company. Kevin Rollins was CEO between 2004-2007, but Michael Dell decided to replace him after 5 quarters of disappointing results.

Understanding Dell’s business segments:

Dell is organized into two segments. They are the Client Solutions Group and the Infrastructure Solutions Group.

ISG brought in $34 billion last year with $3.7 billion operating income. It accounts for 34% of their business. If we assume that this is mostly attributed to the EMC purchase, we can draw conclusions about the rational of the purchase by looking at current operating results. The return on investment is underwhelming but considering that Dell is in a mature stage of growth, it is positive that such a large investment will, at this rate, pay off in less than 20 years. At the current rate, it appears dell is looking at a long-term horizon of 18-20 years where EMC will have to prove its worth. It is hard to tell, but it is likely that Dell only went public for the second time to aid in the EMC acquisition.

ISG accounts for $14.7 billion of goodwill, a substantial amount obtained from the EMC purchase. In the MRQ, ISG brought in more operating income than CSG despite its significantly lower revenue, an attestation to the profitability Dell enjoys from the still lucrative enterprise solutions business.

They have been able to gradually increase revenue from servers and networking due to improvements in the configurations and technology available to customers.

In the server vendor industry, Dell is a significant player, second only to HPE in market share held by a single company. They have the largest market share in OEM storage systems. Dependence on cloud in the modern business drives growth in this segment. ISG capitalizes on hybrid cloud integrations, as well as public cloud support through hardware and software directly for CSP’s. This is a fast growing and profitable industry, and Dell’s positions as an infrastructure provider creates a barrier to exit for existing clients who integrate their infrastructure with Dell.

CSG brought in the majority of revenue at $61 billion, however it cannot attain the same level of profitability, netting $4.3 billion, still a substantial profit margin. They have $4.2 billion in goodwill. Dell ships the third most PC’s out of all vendors and has been able to keep their market share steady over the past decade. They are consistently able to raise prices in CSG, however they are subject to upstream price pressures, which would see margins significantly decrease in cool economic environments.

In CSG, there is significant competition among many market participants who are deeply entrenched in the industry. No single company has anything close to a majority. CSG is heavily exposed to international markets, especially Taiwan and China, however they have no supply chain exposure to Russia and Ukraine, and Russian/Ukrainian operations account for less than 1% of revenue.

Segment industry comparison:

The industry average for PC vendors is an 18% average profit margin, well above the 7% Dell has in CSG, which is indicative of the price it pays for scale. They would have trouble improving this value to industry standards without relinquishing their 16.5% market share for a much smaller share, a clear indication of the competitiveness of this industry.

The industry average for cloud/cloud infrastructure providers is less than two percent. This number is slightly misleading, because seasoned providers like Dell, Azure, HPE, and Amazon are grouped together with Startup cloud companies. Among larger, more seasoned cloud infrastructure providers, average profit margins are closer to 14%. ISG’s profit margin is 11%.

Financial performance:

The financial data only goes back to 2015, however we can look at the figures for Dell EMC from which the financial history for ISG can be inferred.

Dell EMC’s revenue only decreased 5.7% in 2009 but increased by 13.3% in 2010. Their revenue decreased 39% between 2000 and 2002. An implosion similar to the internet bubble would likely produce similar results over the short term, but this should be taken as a floor for shrinkage unless there is some five-sigma event that wreaks havoc in the industry. Profit decreased almost 60% in the same period. If the company has a shaky balance sheet, midterm decreases of 50% can threaten their existence. Given how the company has weathered previous economic downturns and depending on the widespread tech exposure to the economic trends, the company could see losses between 6%-40% in a recession but would not be threatened on the basis of their liquidity in CSG.

Revenue has been exceptional in the past two years. The revenue CAGR is about 12%. Net income was negative before 2019 but has been slightly positive since then.

The company has been teetering around zero equity. As of March second, 2023 (most recent financials), they had liabilities exceeding assets by about $3.03 billion, which is down from minus $1.5 billion the year before. They have a significant cash position of $8.6 billion. Their debt structure is very manageable and spread out over the next 20 years. They have an average of $1 billion a year due except for $4.5 billion due in 2026. 24% of their assets are goodwill, which is not unreasonable for the cash flow it can expect from enterprise clients in the future. If they can control their balance sheet, it would be viable for them to buy back shares. Michael Dell does not like relinquishing control of his company, so this may become reality in the future and he could take the company private.

The quarterly and annual results for 2022 indicate there are hard times to come. They averaged a 2.4% profit margin. Operating cash flows decreased over 60% YoY. Despite this, there has been solid growth in operating cash flows in the past decade due to favorable business conditions, and real growth in a mature client base. The operating cash flows will return when economic conditions ease. Capex has increased with opex, which is mostly attributable to the ISG segment maintenance and expansion.

Valuation:

In projecting the FCF, we should have two sections, one for the next three years resembling the most recent downturn in financial results, and then for the remainder, returning to more normal financial conditions. We will go with a long-term growth rate equal to their growth in a zero rate environment (12.25%) minus the long term target rate of 2%, discounted by the company cost of capital (10%) plus a long term average risk free rate of 5%. Time horizon of 10 years. With this DCF, we arrive at an intrinsic value of $38.89 billion. They have a strong ability to generate cash, and do not have prohibitively high capex. Even with no growth, as long as they can hold their cash flows and keep interest and capex down, they would still be valued at $30 billion. However, there could be significant impairments on the company’s ability to generate cash and raise debt if they cannot get their balance sheet under control.