Dell Can Reach $21 With Business Model Adjustments

DELL: Dell logo

Dell (NASDAQ:DELL) made its mark initially by being ahead of the curve. In the 1990’s it gained market share by selling PC’s from its website which helped it keep costs down by lowering inventory. It was an early innovator in the PC market delivering PC’s at significantly lower prices by streamlining its supply chain. With the PC market now maturing, it seems that Dell is adapting to the changing market scenario. We take a look at why we think our current Trefis Price Estimate is justified. Dell’s major competitors are IBM (NYSE:IBM) and HP (NYSE:HPQ) – the global leader and Dell’s rival in the PC market.
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1) Ultrabooks

Dell has already announced that its Ultrabook range is selling at 3x expected demand and user acceptance of the thin laptops are better than it hoped. The Dell XPS 13 Ultrabook is priced at $999 and significantly lower than the Macbook Air 13 which starts at $1299.

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The Ultrabook may revive the PC market whose margins are low. We estimate that the gross margins for Dell PC’s are in the range of 21 percent. The PC division of Dell constitutes 20 percent of its stock. Another potential winner is the open-source Linux based Ultrabook which is aimed at capturing the web and mobile design and programming market share which is dominated by Macbooks.

If the  cost effectiveness, flexibility and performance offered by the open-source thin laptops can become a more attractive trade-off compared to the design advantages of Macbooks, we can expect programmers and designers to adopt this. If the ultra-book helps increase market share to 15 percent in the same period, we can expect an upside of 8 percent from our current Trefis price estimate.

If margins improve slightly to 27 percent by the end of our forecast period, we can expect a 15 percent upside in the current Trefis price estimate.

It competes in this space with HP and Apple (NASDAQ: APPL)

2) Focus on Services

Currently the services division of Dell constitutes 20 percent of the current Trefis Price Estimate. We estimate that the services gross margin is about 30 percent and will remain the same until the end of our forecast period. Dell has been on an acquisition spree and it making big moves to enter the services in the field of desktop virtualization, thin clients, network security and cloud services. In recent months it has acquired Clerity, Make and Wyse. Wyse is a thin client manufacturer while Make and Clerity are software modernization firms which helps clients move from legacy systems to the cloud. We expect revenue from cloud services to be a very significant driver in the near future.

Cloud computing is an area of high growth but Dell seems to have plans bigger than a mere cloud presence. It is definitely trying to position itself as a service provider as it moves away from the low margins of PC sales. Make and Clerity are in the business of moving legacy systems from individual desktops to servers in an efficient and cost effective manner, and Wyse is in the business of making thin clients that access information from these back-end processes. Essentially it can set up the systems to feed into Wyse clients. This would complement Dells expertise in hardware as its hardware can provide the necessary servers and storage to leverage this.

It also has the sales clout and the reach to scale this business fast. The company is also very likely to make an end-to-end computing solutions platform coupled with services to migrate away from existing systems in the hopes of owning the entire value chain of a computing enterprise suite. Its also acquired SonicWALL Inc. which is a network security and data protection firm, presumably 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 their applications are built from scratch to be pure play cloud computing services as opposed to hosting legacy applications on the cloud.

3) Windows 8 Tablets

This will be its second attempt at capturing tablet market share. The Dell streak range of mobile devices failed to gain traction in the market. We expect Windows 8 to do better as Dell will leverage on existing institutional customers, educational institutions and government contracts to cross sell its tablet range. Currently mobile devices and tablets constitute a combined 1.4 percent of our current price estimate and we expect to see significant growth here if the Windows 8 tablet is successful.

We currently have a $20.48 Trefis Price Estimate for Dell which is 65 percent higher than current price estimates.

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