M E R R I L L L Y N C H Research Comment
Server Hardware & Appliances Reference Number 20130269
United States Oct/29/99 12:48
Steven Milunovich (1) 212 449-2047
BUY
Long Term
BUY
Reason for Report: Company Update
Price: $70 5/8
12 Month Price Objective: $90
Estimates (Dec) 1998A 1999E 2000E
EPS: $0.75 $1.03 $1.45
P/E: 94.2x 68.6x 48.7x
EPS Change (YoY): 37.3% 31.8%
Consensus EPS: $1.08 $1.41
(First Call: 22-Oct-1999)
Q4 EPS (Dec): $0.24 $0.31
Cash Flow/Share: $0.94 $1.41 $1.97
Price/Cash Flow: 75.1x 50.1x 35.9x
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: B-1-1-9
Mkt. Value / Shares Outstanding (mn): $77,193.1 / 1,093
Book Value/Share (Sep-1999): $3.90
Price/Book Ratio: 18.1x
ROE 1999E Average: 22.0%
LT Liability % of Capital: 15.0%
Est. 5 Year EPS Growth: 30.0%
Stock Data
52-Week Range: $78-$31 7/16
Symbol / Exchange: EMC / NYSE
Options: Chicago
Institutional Ownership-Spectrum: 60.1%
Brokers Covering (First Call): 21
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: In Line (07-Mar-1995)
Growth: In Line (06-Apr-1998)
Income & Growth: In Line (06-Apr-1998)
Capital Appreciation: In Line (28-May-1993)
Market Analysis; Technical Rating: Average (25-Oct-1999)
**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 Yesterday's management call could ease investors' minds. EMC combined
with DG will show slower revenue growth but the same or faster EPS gains.
o Our EPS estimate for 4Q falls to $0.31 on lower than expected operating
income from Data General. The deal should become accretive in the second half
by $0.02 -0.05.
o Our price objective of $90 is 62X our 2000 estimate of $1.45, a PEG ratio
of 2.0.
Fundamental Highlights:
o Management expects Data General to provide $300 million in revenue for 4Q
and $1.3 billion in 2000. The combined entity should grow revenue 27% in 2000.
o AViiON sales should decline 25-30% for 2000 as unprofitable segments and
products are abandoned.
o The merged company has a broader product line, a larger served market, and
lower priced products for price-sensitive customers.
Data General's F4Q revenue and earnings were surprisingly strong given the
uncertainty caused by the merger. For Data General's normal reporting period,
a loss of $0.11 missed our $0.09 loss estimate. Reported numbers were made to
conform to EMC's reporting period, adding five days of results. On this basis,
revenue of $375 million was $4 million shy of our estimate and off 2% year-over-
year. AViiON revenue of $154 million beat our estimate by $4 million, while
CLARiiON sales came in at $114 million, up 2% year-over-year. CLARiiON sales
to HP were just $10 million. The gross margin of 31.7% was off 70 basis points
from our projection while operating expenses of $134 million came in about $7
million strong. Reported EPS showed a loss of $0.27 for the quarter.
Bob Dutkowsky gets the job of turning AViiON around. He has taken over as
President of Data General, which will include just the AViiON server division
and associated services. EMC will report Data General's (AViiON and services
only) revenue and gross margin seperately to show the more favorable impact of
CLARiiON on the storage business.
Profitability will be the focus, so the PC product line will likely be
scuttled. DG will exit unprofitable geographies and server product segments,
but will continue to serve the DG/UX user base, high-end NT and NT
consolidation markets, as well as NUMA servers. Given Mr. Dutkowski's
stewardship of the RS6000 division while at IBM, we consider him one of the
best executives for the job.
Declining AViiON and OEM will likely offset rapid direct CLARiiON sales growth.
Management is expecting CLARiiON to contribute $100 million to 4Q revenue and
$600 million to 2000. This is down from the $130 million and $650 million we
had been expecting and reflects management's assumption that some OEM revenue
will evaporate. Management forecast $200 million for 4Q and $700 million of
revenue for AViiON/services next year, down from the $140 million and $890
million we had forecasted prior to the merger.
CLARiiON OEM represents about 80% of revenue with direct sales at 20%, but EMC
looks to flip-flop that by the
end of next year. DG OEM's SGI, Bull, Unisys, Sequent, ICL, and NEC are also
EMC resellers and should continue buying, but StorageTek, Dell, and HP are more
likely than not to go away during 2000. We think EMC could grow the CLARiiON
direct sales significantly faster than EMC's recent 35% growth rate. The
combined EMC/DG company should grow revenue by about 27% to $8.5 billion in
2000.
Look for $0.02 dilution in 4Q and accretion in 2000. On a standalone basis,
Data General's operating loss should be a few million dollars worse than 3Q's
$15 million loss, causing us to cut our estimate for the combined company by
$0.02 for the fourth quarter to $0.31. The impact on EPS for the first two
quarters of 2000 should be neutral while the final two quarters should be
accretive by one to two cents per quarter. Our 2000 EPS estimate for the
combined company is $1.45 on revenue of $8.5 billion, up from $1.40 per share
and $7.2 billion prior to the merger.
The gross margin for the combined storage unit should approach EMC's product
margin of 55-57% by the end of next year as the lower margin OEM contribution
fades. AViiON's margin impact will be broken out, but the current mid- to high-
30s margin should increase 300 to 500 basis points as less profitable lines are
pruned. CLARiiON's margins, currently in the low 30s due to OEM sales, will
grow towards EMC's high-40s to low-50s storage margins as the direct sales mix
increases. The new overall gross margin is 53.4% for 2000, down from 55.3%
before the merger; this is not a bad thing since EMC can begin to grow margins
again. Operating expenses as a percent of revenue should match EMC's
traditional rates late next year.
EMC/DG has a bigger market and more ammunition. Mergers in the technology
industry have a spotty record, but we remain positive on the Data General/EMC
marriage. The acquisition means EMC will address a $50 billion market in 2001,
up from the smaller $35 billion projection prior to the merger. And DG's share
of the middle market is less than 10% compared to EMC's 60% share of the
mainframe market and 35% share of open systems storage. EMC now has cheaper
storage to offer price sensitive customers, some of which it lost in the past.
(Panel 1)
Table 2: Data General Earnings Model, 1998-1999 Actuals
($ millions except EPS)
1998A
Dec Mar Jun Sep
Sales $267.2 $263.7 $253.8 $283.2
Services 98.1 98.1 97.5 100.5
Total Revenue $365.3 $361.8 $351.3 $383.7
Cost of Sales $189.2 $190.7 $189.2 $201.8
Cost of Services 60.2 63.1 59.9 62.3
SG&A 84.4 85.1 84.7 83.9
R&D 27.4 28.9 31.7 30.7
Operating Income $4.1 ($6.0) ($14.2) $5.0
Net Interest Expense 0.1 (2.0) 0.4 0.3
Other Income (Expense) 2.0
Effective Tax Rate 12.5% -12.5% -6.8% 21.3%
Pretax Income $4.0 ($4.0) ($14.6) $4.7
Taxes 0.5 0.5 1.0 1.0
Net Income $3.5 ($4.5) ($15.6) $3.7
Earnings Per Share $0.07 ($0.09) ($0.32) $0.07
Avg. Shares (mil.) 50.7 48.9 49.2 50.5
As a % of Revenue
Revenue 100.0 100.0 100.0 100.0
Gross Profit - Sales 29.2 27.7 25.5 28.7
Gross Profit - Services 38.6 35.7 38.6 38.0
Gross Margin 31.7 29.9 29.1 31.2
SG&A 23.1 23.5 24.1 21.9
R&D 7.5 8.0 9.0 8.0
Operating Income 1.1 (1.7) (4.0) 1.3
Pretax Income 1.1 (1.1) (4.2) 1.2
Net Income 1.0 (1.2) (4.4) 1.0
Year-Over-Year Growth (%)
Sales 7 (10) (14) (8)
Services (1) 1 0 3
Total Revenue 5 (7) (10) (5)
Gross Profit - Sales (8) (22) (32) (16)
Gross Profit - Services 10 (1) 6 4
SG&A 5 (0) (1) (3)
R&D 5 7 14 6
Operating Income (66) NM NM NM
Pretax Income (64) NM NM NM
Net Income (66) NM NM NM
EPS (72) NM NM NM
Sequential Quarterly Growth (%)
Sales (13) (1) (4) 12
Services 1 0 (1) 3
Total Revenue (10) (1) (3) 9
Gross Profit - Sales (10) 1 (1) 7
Gross Profit - Services (1) 5 (5) 4
SG&A (3) 1 (0) (1)
R&D (5) 5 10 (3)
Operating Income (77) NM NM NM
Pretax Income (77) NM NM NM
Net Income (79) NM NM NM
EPS (80) NM NM NM
(Panel 2)
Table 2: Data General Earnings Model, 1998-1999 Actuals
($ millions except EPS)
1999A
Dec Mar Jun Sep
Sales $268.8 $257.7 $259.7 $281.1
Services 96.8 97.6 96.2 94.1
Total Revenue $365.6 $355.3 $355.9 $375.3
Cost of Sales $184.1 $177.1 $180.4 $193.7
Cost of Services 60.8 61.4 60.3 62.4
SG&A 86.5 86.3 90.9 102.1
R&D 28.9 28.6 28.8 31.8
Operating Income $5.3 $1.9 ($4.5) ($14.8)
Net Interest Expense 0.8 (0.2) (1.0) (1.2)
Other Income (Expense) 5.4 3.0 3.0
Effective Tax Rate 22.4% 19.0% -10.9% -5.8%
Pretax Income $4.5 $2.1 ($5.5) ($13.0)
Taxes 1.0 0.4 0.6 0.8
Net Income $3.5 $1.7 ($6.1) ($13.7)
Earnings Per Share $0.07 $0.03 ($0.12) ($0.27)
Avg. Shares (mil.) 51.2 51.6 50.6 51.0
As a % of Revenue
Revenue 100.0 100.0 100.0 100.0
Gross Profit - Sales 31.5 31.3 30.5 31.1
Gross Profit - Services 37.2 37.1 37.3 33.7
Gross Margin 33.0 32.9 32.4 31.7
SG&A 23.7 24.3 25.5 27.2
R&D 7.9 8.0 8.1 8.5
Operating Income 1.4 0.5 (1.3) (3.9)
Pretax Income 1.2 0.6 (1.5) (3.5)
Net Income 0.9 0.5 (1.7) (3.7)
Year-Over-Year Growth (%)
Sales 1 (2) 2 (1)
Services (1) (1) (1) (6)
Total Revenue 0 (2) 1 (2)
Gross Profit - Sales 9 10 23 7
Gross Profit - Services (5) 3 (5) (17)
SG&A 2 1 7 22
R&D 5 (1) (9) 4
Operating Income 29 NM NM NM
Pretax Income 12 NM NM NM
Net Income (1) NM NM NM
EPS (2) NM NM NM
Sequential Quarterly Growth (%)
Sales (5) (4) 1 8
Services (4) 1 (1) (2)
Total Revenue (5) (3) 0 5
Gross Profit - Sales (9) (4) 2 7
Gross Profit - Services (2) 1 (2) 4
SG&A 3 (0) 5 12
R&D (6) (1) 1 10
Operating Income 5 (64) NM NM
Pretax Income (5) (53) NM NM
Net Income (6) (51) NM NM
EPS (7) (51) NM NM
(Panel 3)
Table 2: Data General Earnings Model, 1998-1999 Actuals
($ millions except EPS)
Full Year
1998A 1999A
Sales $1,067.9 $1,067.3
Services 394.2 384.7
Total Revenue $1,462.1 $1,452.1
Cost of Sales $770.9 $735.3
Cost of Services 245.5 244.9
SG&A 338.1 365.8
R&D 118.7 118.1
Operating Income ($11.1) -12.1
Net Interest Expense (1.2) (1.6)
Other Income (Expense)
Effective Tax Rate -30.3% -23.1%
Pretax Income ($9.9) ($11.9)
Taxes 3.0 2.8
Net Income ($12.9) ($14.7)
Earnings Per Share ($0.26) ($0.29)
Avg. Shares (mil.) 49.8 51.1
As a % of Revenue
Revenue 100.0 100.0
Gross Profit - Sales 27.8 31.1
Gross Profit - Services 37.7 36.3
Gross Margin 30.5 32.5
SG&A 23.1 25.2
R&D 8.1 8.1
Operating Income (0.8) (0.8)
Pretax Income (0.7) (0.8)
Net Income (0.9) (1.0)
Year-Over-Year Growth (%)
Sales (7) (0)
Services 1 (2)
Total Revenue (5) (1)
Gross Profit - Sales (0) (5)
Gross Profit - Services (1) (0)
SG&A (0) 8
R&D 8 (1)
Operating Income NM NM
Pretax Income NM NM
Net Income NM NM
EPS NM NM
Sequential Quarterly Growth (%)
Sales
Services
Total Revenue
Gross Profit - Sales
Gross Profit - Services
SG&A
R&D
Operating Income
Pretax Income
Net Income
EPS
Source: A=Actual E=Merrill Lynch Equituy Estimates
Opinion Key (X-a-b-c): Investment Risk Rating(X): A - Low, B - Average, C -
Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12
mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 - Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9
- No Cash Dividend.
Copyright 1999 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S).
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