Merril note.
Dell Computer Corp – 22 May 2001
On the Road with Dell
Yesterday we were on the road with Dell President and COO
Kevin Rollins visiting investors.
• Dell has not seen any indication that demand has turned
favorable. The company continues to expect a turn only in
the 4Q timeframe due to such drivers as Windows XP,
Intel’s P4 (Brookdale chipset with SDRAM), and the
beginnings of the Y2k refresh cycle. XP should especially
help to drive consumer demand. Note that the high water
mark for pre-Y2k spending was 2Q99, so a three year
replacement cycle for desktops implies that 2Q02 should be
the high water mark for the Y2k replacement cycle.
Importantly, Dell is not expecting any further tanking of
overall demand.
• Dell sees the current environment of very weak demand as
the ideal period in which to accelerate its market share gains
as customers are much more price sensitive. When demand
improves, component prices drop less quickly, profits
improve and price aggression is less likely and less effective
– even Dell’s less efficient competitors can sell PCs at a
profit. Market share gains have always been sticky for Dell,
and the company sees its current gains through aggressive
pricing as fuel for its future growth. Dell believes that its
aggressive pricing combined with very weak demand could
cause consolidation in the industry. Eventually Dell sees the
top three players with a total of 80% market share, much
higher than now.
• While Dell’s margins should improve when demand returns,
the company manages to the operating margin line and will
tend to drive gross margin in lockstep with operating
expense improvements.
• Dell believes that the PC industry can get back worldwide
unit growth in the 10-15% range.
• Dell management emphasized three growth drivers for the
company going forward:
1. The mix shift to enterprise hardware - Dell continues to
sell an increasing percentage of higher-end products
(notebooks, servers, storage). Desktops now make up
only a little less than 50% of revenue. The current
“sweet-spot” of commoditizing products is the low-end
Wintel server segment. Dell sees its near-term
opportunity in increasingly more capable and complex
servers (4-way, 8-way). Next is external network
attached storage (NAS).
2. Geographic expansion - Dell is already improving its
performance in the important European market where
its business is back on track after a difficult 2000.
Much opportunity exists in markets around the world.
Dell currently has 23% share in the 48% of worldwide
markets where it is best established, but only 6% in the
remaining 52%.
3. Exploit the Dell model - The company wants to exploit
its significant cost advantage to gain market share.
Market share gains will only be pursued if they are
profitable, so Dell is looking for somewhat stable
operating margins going forward (near 7%). Margins
and revenue growth at the low end of expectations
should only occur if the company sees irrationally low
pricing by competitors.
• Dell sees price cuts by Intel as especially advantageous.
Dell can quickly pass these price cuts on to its customers. A
large spike in Dell sales of systems including Intel’s P4
processor should occur towards the end of the year when the
Brookdale chipset (with SDRAM) is available.
• Dell is not currently considering AMD or Transmeta
processors. Dell prefers to remain single source (Intel) to
reduce complexity as long as Intel can keep prices declining.
• Dell is seeing pockets of relatively strong demand such as a
strong Y2k replacement cycle in the public sector in the US
and Canada (i.e., federal, state and local governments as
well as schools).
• Server sales are growing very quickly (better than notebooks
or desktops) and Dell’s price aggression is focused on this
segment. Server sales pull in significant service and storage
revenue as well, so they are particularly valuable.
• Dell’s focus on storage is to soak up all of the small/midsize
demand, not to play at the high end versus the likes of EMC
or HDS.
• Dell sees services as an enabler of hardware sales, especially
for higher-end systems. Services, in a sense, act as a
wrapper around hardware that is becoming thicker and
thicker. Dell intends to beef up its services offerings, but
does want to become a full-fledged services company like
EDS.
• Dell will not play in PDAs until the products become more
standardized and until volume sales are made through the
front doors of IT departments.
• The company is looking at selective acquisitions to get
certain segments/categories launched or enhanced with
appropriate scale.
• We are maintaining our Buy rating on Dell shares with a
price objective of $32 that is based on 35x our $0.90 EPS
estimate for fiscal 2003 (calendar 2002). |
