Dell’s Services Business Will Come Under Scrutiny In Earnings
Dell (NASDAQ:DELL) is due to report its Q3 earnings on November 15, 2012, and we will be paying close attention to its services business as the company tries to diversify its business away from PC hardware. Dell has focused on revamping its business model in the recent past and the effect of services, ultrabooks, Wyse thin-clients and cloud services is likely to influence earnings to a greater extent. It is targeting $5 billion in software sales in the near future and plans to do so by offering services in key areas such as network security, cloud storage, systems management, business analytics, virtualization and thin client systems. Dell is also venturing into the cloud storage space with project Hermes.
In Q2, revenue came in at $14.5 billion, down 8% y-o-y, with an operating income of $1.1 billion and cash flow from operations of $637 million. Earnings per share declined 7% y-o-y to $0.50. The company has also issued a lowered EPS guidance for the year and expects EPS to be at least $1.7 for the fiscal year.
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Changing Business Model And Weak PC Sales Dims Outlook
According to Gartner, Dell owns about 10% of the PC market as of Q3, 2012, down nearly 14% y-o-y from 11.2% same time last year and this may not necessarily be a bad development for the company as it is focusing on higher margin businesses. Its low earnings growth may be due to the shift from hardware to services and some short-term pain can be expected, as with most business model changes.
Currently, the services division of Dell constitutes around 23% of the current Trefis price estimate. Dell has been making a lot of acquisitions to enter services in the fields of desktop virtualization, thin clients, network security and cloud. It acquired Wyse, Make and Clerity. Wyse is a thin client manufacturer while Make and Clerity are software modernization firms that help clients move from legacy systems to the cloud. We expect revenue from cloud services to be a significant driver in the near future.
Dell also acquired SonicWALL Inc. , a network security and data protection firm, in an effort to fortify its cloud business initiatives. This will make Dell compete against the likes of IBM, HP, Cisco and Juniper. The advantage for Dell though is that its applications are built from scratch to be pure play cloud computing services. We expect the new software division to grow rapidly as it tries to hit the $5 billion services target.
We currently have a $19.22 Trefis price estimate for Dell, which is nearly double the current market price. Our valuation is contingent of its performance in the services business and is based on the long term potential of its high margin businesses. We detail our analysis here.
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