Dell (NASDAQ:DELL) has been in the news a lot lately with its stock falling sharply after missing Q1 earnings and forecasting weak sales for Q2 as well. Prominent investors such as Jim Chanos, founder of hedge fund Kynikos Associates, and David Einhorn, founder of hedge fund Greenlight Capital, have taken opposite stances, further fueling the debate on the future on the company. Jim Chanos is currently short Dell  while David Einhorn is still long Dell as of May 21. 
Chanos believes that Dell is a value trap and argues that tablets are slowly replacing traditional PC’s. He also states that the PC business has trended towards a commodity like business over the years and that the enterprise hardware business is headed in the same direction. However, David Einhorn argues that Dell has been actively diversifying and that the company is more enterprise oriented and not as heavily dependent on retail customers as it used to be. We take a look at some of the factors that we think justify our outlook on Dell and its current Trefis price estimate.
1) Enterprise Hardware Is Evolving And May Not Become Commoditized In The Near Future
The PC market has arguably been slowly trending towards a commodity like business since the late 90′s and early 2000′s. However, companies such as Dell have been able to offset this trend by offering customers a differentiated shopping experience online and by outsourcing manufacturing to countries such as Thailand to lower costs. While we agree that the enterprise hardware market will also become more commodity-like in the future and that margins in that industry will slowly decline, we believe that companies like Dell can offset these trends through differentiation by improving their products to include cloud based infrastructure and by switching to all flash storage drives to increase speed and performance.
2) Increasing Focus on Services, Cloud Computing And Enterprise Software
Dell has been on an acquisition spree and has been visibly changing its business strategy by focusing more on cloud services, thin clients and software modernization. It is gaining traction in the virtualization space with acquisitions of Clerity, Make and Wyse while also acquiring players in the network security space. We expect to see revenues from virtualization and software modernization to be significant in the coming quarters.
The advantage of becoming more service oriented is that clients are locked into long term contracts which offer high predictability of revenues in the future. Additionally, clients tend to be very sticky since changing service providers can result in significant downtime and thereby a decline in productivity. We estimate that Dell’s gross margins for services to be in the range of 30 percent and can potentially be higher for services such as modernization and virtualization.
3) Ultrabooks And Tablets
The Ultrabook is currently the closest a laptop can get to the size and portability of a tablet without losing the performance and capabilities of a laptop. The Dell XPS 13 Ultrabook has been a bit hit so far with customers and has seen sales surge to 3x expected demand. While this is not an indicator of the long term success of the ultra thin range of PC’s, the initial acceptance is a good sign for Dell. We expect demand to continue to stay strong for ultrabooks.
In the tablet space, we are still waiting to see how well Windows 8 based tablets will be adopted by the market. Success in the tablet space is critical and a must win for Dell as it has to become a relevant player in the tablet space to stay competitive in the retail PC market. In the mean time Dell’s Ultrabook initiative should act as a hedge of sorts helping the company maintain a foothold in the retail PC space.
Currently, Dell is still primarily a hardware and PC manufacturer. While services constitutes only 20 percent of the current Trefis Price Estimate, hardware, storage, PC’s and laptops constitute 60.5 percent of our current price estimate and the rest is cash net of debt. Over time we expect Dell to continue expanding its services offerings and continue innovating in its hardware divisions to offset any commoditization of the markets. This should help keep Dell a viable and profitable company that continues to create value for its shareholders.
We currently have a $20.48 Trefis Price Estimate for Dell, which is ~65 percent higher than the current market price.Notes:
- Jim Chanos Shorting Coinstar & Dell, www.marketfolly.com, April 12, 2012 [↩]
- Tracking David Einhorn’s Greenlight Capital Portfolio – Q1 2012 Update, seekingalpha.com, May 21, 2012 [↩]