Dell (NASDAQ: DELL) reported better than expected Q3 earnings driven by higher sales and margins. Dell’s services revenue in particular grew by 55% (or $2 billion) for the first nine months of fiscal year 2011, largely due to last year’s acquisition of Perot System by Dell.
We believe the services business is the biggest value driver for Dell accounting for 25% of the business. Our Trefis price estimate of $18.60 for Dell’s stock is around 30-35% above the current market price, and we note if the Managed Services and Consulting business grows at 10% annually, this would add another $2 to our price estimate.
Dell’s reported earnings showed a pick-up in sales on the heels of strong corporate segment spending confirming that the corporate refresh cycle is underway. Profit margins also came in at higher levels due to lower component cost, though we expect this to normalize in coming quarters. Management raised the earning guidance from mid-teens to 30% for the full year. Michael Dell also pointed to continued growth in the services segment and emphasized the transition of the company from a IT hardware company to a IT services company.
We wrote recently about the PC refresh cycle after Microsoft’s earnings as corporates are investing in IT hardware and services to replace old systems. (See Micrsoft Rises on PC Refresh Cycle.)
This follows a slowdown in IT spending in recent years. The demand for services is picking up as companies see hardware and software upgrades as investments in a company’s future that help increase productivity and reduce future costs. This should continue to support the IT hardware and software industry.
Managed Services and Consulting currently makes up 25% of our estimates for Dell, and if this unit grows at 10% annually versus our current low single-digit estimate, this would add another $2 to our price estimate – or an additional 15% of the current market price.
You can drag the forecast trend-lines above to express your own view, and see the sensitivity of Dell’s stock to IT Services and Consulting business.