DELL Analyst Meeting: 4/9/99 (Part 4, Merrill Lynch)
02:23pm EDT 9-Apr-99 Merrill Lynch (S.Milunovich/K.Campbell) DELL IBM
IBM/ 668
DELL COMPUTER:Plenty of Headroom- Part 1
ML++ML++ML Merrill Lynch Global Securities Research ML++ML++ML
DELL COMPUTER CORP (DELL/OTC)
Plenty of Headroom- Part 1
Steven Milunovich (1) 212 449-2047
Kirsten Campbell (1) 212 449-3113
ACCUMULATE*
Long Term BUY
Reason for Report: Analyst Meeting- Part 1
Price: $46 7/16
12 Month Price Objective: $55
Estimates (Jan) 1999A 2000E 2001E
EPS: $0.53 $0.72 $1.00
P/E: 87.6x 64.5x 46.4x
EPS Change (YoY): 35.8% 38.9%
onsensus EPS: $0.73 $0.98
(First Call: 07-Apr-1999)
Q1 EPS (Apr): $0.11 $0.16
Cash Flow/Share: $0.57 $0.78 $1.05
Price/Cash Flow: 81.5x 59.5x 44.2x
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: B-2-1-9
Mkt. Value / Shares Outstanding (mn): $127,703.1 / 2,750
Book Value/Share (Jan-1999): $0.84
Price/Book Ratio: 55.3x
ROE 2000E Average: 59.8%
LT Liability % of Capital: 18.1%
Est. 5 Year EPS Growth: 30.0%
Stock Data
52-Week Range: $55-$16 9/16
Symbol / Exchange: DELL / OTC
Options: Phila
Institutional Ownership-Spectrum: 37.4%
Brokers Covering (First Call): 31
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: In Line (07-Mar-1995)
Growth: Overweight (07-Mar-1995)
Income & Growth: Overweight (07-Mar-1995)
Capital Appreciation: In Line (16-Sep-1997)
Market Analysis; Technical Rating: Average (29-Mar-1999)
*Intermediate term opinion last changed on 13-Nov-1998.
**The views expressed are those of the macro department and do not
necessarily coincide with those of the Fundamental analyst. For full
investment opinion definitions, see footnotes.
Investment Highlights:
o Although we prefer enterprise over PC stocks, the purity of Dell's
model is attractive relative to a hybrid model.
o Michael Dell exemplifies the Law of Focus. The reason we believe
Dell will win is that it will gain mindshare as the PC specialist and
can outexecute competitors with a low-cost model.
o We maintain our Accumulate rating. Dell's not a Buy due to high
valuation and slowing growth. We do think the April quarter will come
out at $0.16 per share on 38-40% revenue growth.
Fundamental Highlights:
o Dell emphasized its ability to grow market share in justifying
continued high growth. We do agree that direct will be the dominant
model, which is not reflected in Dell's share.
o The company is moving more into the consumer market but only in
higher-end segments. Dell can make good money at $999 (though not at
$400) with an infinite ROIC.
o We sense that Dell will only provide PCs to IBM if they are
Dell-labeled. Our guess is that IBM won't go for that, so a near-term
deal is unlikely.
Dell Computer hosted its semi-annual analyst meeting yesterday in New
York.
Dell estimates that the PC industry's unit growth for the next three
years will be about 14%. While this is in synch with our own 13-15%
estimate, we note that this has been reduced from Dell's previous
estimate of 17%. However, we continue to believe that the real issue
for the PC industry is revenue not unit growth. Our forecast of 5-7%
revenue growth for the industry will provide a challenging environment
for PC vendors.
Despite this modest revenue growth in the industry, Dell emphasized its
ability to grow market share, in addition to moving into new product,
customer and geographic markets, in justifying expectations for
continued high growth. According to Tom Meredith- The Internet is the
single biggest gift in Dell's lifetime. The Internet will help grow the
direct model in time to over 50%, up from only about 30% today. As
Dell's addressable market (direct) and its share within this addressable
market both grow, Dell believes it can sustain top line growth of over
30%. We agree that direct will be the dominant model, which is not
reflected in Dell's current market share of only 14% domestically, and
5% outside the US.
Dell is countering slowing PC growth by moving beyond the box. Dell is
continually transitioning from a box maker to a technology partner. Dell
is increasingly focusing on services and higher-end products to better
offer technology solutions to its customers. The new markets are
nothing to laugh at-the service business is an estimated $1.8 billion
market, growing at a rate faster than Dell and with higher margins.
The company seems to be backing off somewhat on prior optimism about the
effect of Y2K. While the commentary remains that large corporate will
finish its Y2K related purchases in the first half and government (for
which Dell is the largest computer supplier) and SMB in the second half
of the year, our sense was that the company is less optimistic about Y2K
spurring upside in demand.
Dell recently made two endorsements to the open source software
operating system, Linux. Dell has made a minority investment in Red
Hat, and is working with Red Hat to factory install Red Hat Linux on
Dell servers and workstation, as well as desktops later this year. Dell
recently announced an agreement with BURLINGTON Coat Factory to ship
1,250 custom configured Linux-based Opti-Plex desktops. We believe that
open source software will increasingly become and important trend effect
enterprise hardware and software vendors both. While such moves toward
Open Source Software most likely do not work to strengthen Dell's
relationship with Microsoft, Dell noted that it is not a subsidiary of
Microsoft and that it makes decisions based on its customers needs. For
more information on Linux, please join our Monday, April 12(**th), as we
host our Open Source Software conference call with guest speakers, Jon
Hall of Compaq, Bob Young of Red Hat, and Tony Iams of D.H. Brown.
Michael Dell acknowledged the consumer trend of moving more toward a
cell phone model to subsidized the cost of the hardware by securing
future IPS revenue streams. While Dell has not attempted this model
yet, Dell is increasingly forging into the consumer market but only in
higher-end segments. So far the metrics have been impressive. For
instance, due to Dell's no inventory model plus the lack of consumer
receivables (all credit card transactions), Dell has an infinite RIOC in
this space. Dell can make good money at $999 (though not at $400).
Dell also noted that these products are appropriately prices, with the
margin/price ratio Dell's staying constant as it expands into toward
lower end products. Dell is not currently offering $400-500 PC, and
going at its own pace in entering the consumer market, which we believe
the smart. However, we think this could prove to be a slippery slope,
possibly forcing Dell's prices lower more quickly than it anticipates.
Dell indicated it does not have near term plans to enter into the
handheld market. It pointed out that the total market for handhelds is
well below $1 billion, with the Palm Pilot at about $600 million and
Windows CE products only $200. Dell's strength is in efficiently
pumping out quality products in volume. We expect Dell will eventually
be involved in the handheld market, but only after the revenue and more
importantly the profit pool increase substantially. Dell indicated that
in its consumer segment, that 38% of the> profits come from non-systems
revenue, e.g. peripherals, financing, extended warranty, etc.
With the March launch of Gigabuys.com we believe this percentage could
increase. As Gigabuys.com is integrated into Dell's 15,000 existing
corporate Premiere Pages and is built into new ones, we believe this
will present an even bigger opportunity for Dell to grow its non-systems
revenues and profits. (DELL) The securities of the company are not
listed but trade over-the-counter in the United States. In the US,
retail sales and/or distribution of this report may be made only in
states where these securities are exempt from registration or have been
qualified for sale. MLPF&S or its affiliates usually make a market in
the securities of this company.
Dell has also significantly grown its Global Customer Program from 30
firms and $409 million in F96 to over 60 firms and $1.8 billion in
F99. Dell estimates that this market segment spends $15 billion on
computer products each year and plans to continue to attack this
segment. Michael Dell exemplifies the Law of Focus. The reason Dell
will win is that it will gain mindshare as the PC specialist and can
outexecute competitors with a low-cost model. Our surveys mirror
this, showing Dell gaining the most share in corporate accounts.
Further customer segmentation is good news for Dell. The various
segmentation of operating systems (Window 9x, NT, UNIX, Linux) and
processors (Celeron, Pentium III and Xeon), helps Dell target even more
focused customers groups, which has helped fuel Dell's success to
date. Not only does it allow Dell to strategically differentiate
itself, it gives Dell important demographic data on its customers.
While Dell's model is currently a demand pull model, it could use
this information to work towards opening up a demand push model as
well.
Dell continues to focus on liquidity, profitability and growth to
increase shareholder value. Dell ended last year with $3.2 billion in
cash (generating $2.4 billion in cash flow from operations during the
year). Its EPS grew 66% last year, while its ROIC was 195%. Revenues
grew 48%, pushing Dell to the #2 US PC vendor and the #3 worldwide
vendor. Dell's low inventory model also helped it achieved a negative
cash conversion cycle of 12 days last year. Dell also reminded
investors of the importance of high inventory turns in a declining
component cost environment. Component prices typically drop about one
half a percentage point per week. While during parts of last year
prices were falling at double this rate, current decline rates are back
to historical norms. If Compaq has 8 weeks of inventory (between
itself and its channel partners) and Dell only has one, a 1/2 point per
week decline means a 3.5% cost of materials advantage.
At the same time, Dell is focusing on the customer experience. More
and more, customer experience is becoming a determining factor in
winning customers and creating mindshare. The crucial differentiating
factor in PC vendors today is moving away from supply chain management
(as all the indirect vendors have attempted to replicate some aspect of
Dell's direct model) to the customers experience and the ability for
the vendor to touch each customer.
Outlook
Our sense is that demand is good, and that Dell hasn't experienced any
unusual pricing pressure. Although we prefer enterprise stocks over PC
stocks, the purity of Dell's model is attractive relative to a hybrid
model. Tom Meredith, CFO, reiterated that they are seeing strength in
all geographies, customer segments and product categories, and Dell
historical sees a 1Q sequential increase over Q4. This sound to us
like the quarter is going well. We are expecting Dell to earn $0.16 per
share on 38-40% revenue growth for the April quarter. We continue to
rate the shares of Dell an Accumulate rather than a Buy, due to
Dell's high valuation and slowing growth. |
