Dell’s Margins Slip Even As Revenues Stabilize

Amid the battle to take it private, Dell (NASDAQ:DELL) announced its Q2 results on August 15. While the company reported no growth in its revenues at $14.5 billion, its net income declined by 51% y-o-y to $475 million. ^[1] The challenging business environment continued to affect its PC hardware business as revenues declined by 5% y-o-y to $9.1 billion. However, Dell’s server and networking division reported 10% y-o-y growth in revenues, driven by demand for its hyper-scale data center servers. Additionally, Dell’s services division reported 2% y-o-y growth in revenues to $2.13 billion. However, Dell’s gross margins slipped by 300 basis points y-o-y to 18.5% as its aggressive pricing strategy to gain market share negatively impacted margins.

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Service Revenues Stabilize

The services division contributes only ~15% to Dell’s revenue but makes up 30% of its estimated value. Dell is actively pursuing growth in this division by expanding its services in network security, cloud storage, systems management, business analytics and virtualization domains.

In Q2 FY14, the revenues for this division grew by 2% y-o-y to $2.13 billion. However, operating profit margins were flat at 16%. Additionally, Dell’s security and infrastructure systems management division reported a 5% y-o-y growth in revenues to $600 million. Dell is targeting $5 billion in sales in the coming years, and it plans to achieve this by targeting key areas such as network security, cloud storage, systems management, business analytics, virtualization and thin client systems. We believe services division to be the key growth driver for Dell and as it expands its portfolio in the services domain, and we expect revenues to increase to $11.5 billion by the end of our forecast period.

Server and Networking Division Drives Top Line Growth

The server and networking division is Dell’s second largest division and makes up ~10% of its total value. For the quarter, Dell reported a 10% y-o-y increase in revenues to $2.89 billion. According to preliminary data available from IDC, the global server revenues declined in Q2. ^[2] However, Dell reported growth in volume and increase in market share during the Q2 calendar quarter driven by demand for its hyper-scale data center servers.

However, Dell has been aggressive with its pricing to win market share. This strategy affected operating margins for the division since margins declined by 80 basis points y-o-y to 4.1% in the quarter. We expect Dell to continue to price its server aggressively that will increase its sales volume, but negatively impact its margins. Currently, we project the average selling price (ASP) of server to decline to ~$200,000 and server shipments to grow to 3.68 million by the end of our forecast period.

Mixed results For EUC Division

The PC and mobility division together with the hardware peripheral division forms the end user computing (EUC) division of Dell. The EUC division reported a 5% y-o-y decline in revenue to $9.13 billion. Additionally, operating margins for this division slipped 500 basis points to 2.1% in the quarter. We expect revenues from this vertical to continue to suffer due to intense competition from incumbents and pricing pressure on Dell.

Weak PC demand across the world continued to plague computer manufacturers as PC shipments declined by 11% in Q2 2013. However, Dell was the only vendor to report sequential and y-o-y growth in PC unit-shipment share in the calendar quarter, according to IDC. ^[3]

Dell has recently shifted its focus from the lower-end to the mid and high-end PC market. This shift positively impacted its revenues as the company reported a marginal increase in its desktop revenues to $3.55 billion. However, we expect that fall in global PC demand and prices will negatively impact Dell’s desktop revenues in the future. Currently we project, Dell’s desktop prices to decline to $500 by the end of our forecast period.

Dell’s mobility business, which includes netbooks, tablets and mobile phones verticals, reported a 10% y-o-y decline in revenues to $3.57 billion. The competition in mobility vertical from incumbents such as Apple (NASDAQ:APPL) is intense and Dell continues to strive for higher market share by aggressively pricing its products. While this may increase Dell’s market share, we believe this will erode Dell’s profitability. Additionally, it will also negatively impact its revenues. Currently, we estimate that prices for its netbook and notebook will decline to $500 by the end of our forecast period.

We are in the process of updating our model for Dell and have a $13.33 Trefis price estimate, which is in line with its current market price.

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1. 8-k [↩]
2. IDC Q2 Server Data, August 13 2013, www.crn.com [↩]
3. Lenovo Overtakes HP as the Top PC Vendor While U.S. Shipments Stabilize in the Second Quarter of 2013, July 10 2013, www.idc.com [↩]