Dell reminds me of 3com, though the situations of the 2 are drastically different. 3com's days of being a franchise business ended 18 months ago, when Intel moved into NICs, and price pressure from competitors arose in virtually all of its market segments. Its business was being commoditized. After I sold the stock, I wrote an article on 3com thread last summer, when it was trading in the 50s. The 3com bulls just could not stand that dose of reality, and called my analysis disjointed. But a year later, 3com's stock is down 40%, AND ITS MARGINS are razor thin, as it struggles with intense competition. I see a similar situation developing with Dell. Compaq is gearing up its efforts to copy dell's revolutionary production and marketing strategy, which, to the chagrin of Dell bulls, is not and probably cannot be patented. When Compaq adopts the same strategy, needless to say Dell's advantage will disappear, and a price war will ensue. But obviously Compaq cannot expect to master instantaneously the art of direct marketing and outsourcing production; there will be a few flaws that will have to be sorted out; what Compaq can do with this initiative, however, is to challenge Dell's market share. That is the most important element in this battle. Profits, at least for now, are of secondary concern. Few PC makers are more than marginally profitable. And the most prominent exceptions to this rule are the direct-sellers, Dell and GTW.
Commoditization of the PC business, or, should I say, Dell's business, is a long process that will take several months at least, or
maybe even a year or two. By the end of it, margins and multiples will ressemble those of other major commodity-like industries, such as steel, autos, DRAM makers, Disk-drive makers(gee, aren't the last two suppose to be high-tech?) etc. where products from different manufacturers are barely differentiable from each other and where margins are barely enough for the companies to subsist. Already, the PC industry is bearing many traits of a commodity-like industry:
Compare a PC from Dell and Compaq: what noticeable difference is there? Same disk drive, Same CPU, Same graphics card, Same motherboard, Same monitor, Same modem or NIC, same motherboard, etc.
Sure, they might not be the same, depending on the customer's tastes, but come from the same 3 or 4 manufacturers for each peripheral product. The difference, however, is the Price. Compaqs in stores are a lot more expensive than comparable dell models. Same for GTW. That's because of the above-mentioned advantages Dell possesses, namely direct selling and production subcontracting. Once Compaq adopts these measures, everything will be the same or similar for both PCs, even the price. And Dell would become just another PC maker, trading at 8-10 times earnings.
One can argue that the PC market as a whole will be 10 times bigger 20 years from now, as emerging markets buy them en masse. Sure, but will the corresponding 10-fold increase in profits be there also?
PC markets have been growing for upwards of 17% a year for the past 3 years, but has that translated into an annual 17% profit increase for CPQ, Packard Bell, IBM, Acer and other PC manufacturers? The answer is no. It has translated into losses for some of these, as opposed to profits 3 years ago, while Dell ang GTW have been consistently snapping up market share. But when everyone will be on an even playing ground, using direct selling, production outsourcing, etc, and with those failing to adopt such measures forced out of the industry, will there still be the 40-50% annual growth in earnings for Dell? I think not.
The transition to this universal standard business model has already begun, as it is literally a matter of do or die for the slumbering PC giants. This will also mean an end to Dell's days of rampant growth. The effects will gradually be felt, and gradually illustrate itself on Dell's stock price.Dell's story will unwind much in the way Intel's is, but with one critical exception: Intel is still a franchise company. It can still count on new chip releases to boost earnings. Dell can't. Everything that It can do, its competitors can theoretically match. By the quarter after next one,in November, Dell may not be able to beat estimates as it consistently has in the past; it will probably come in at or slightly below; slowing growth warning will be issued for the coming quarters; and the trend will persist. At
first, Stock will correct, and "value" investors will jump in, feeling this is just a short-term glitch; but the ensuing quarters will demonstrate what is really happening.
I agree with you that on one can put a precise date on the beginning of the slide. Mine is an estimate. By that date, one should expect to see the first impacts of compaq's move on dell's bottom line, regardless of what Dell does(what can they do, that will not hurt the stock price? Sue compaq for patent infringement?). But sooner or later, the effects will be felt. Michael Dell seems to know that. He already sold 3.45 million shares in the last 9 months, split adjusted, while ironically increasing the company's share buyback program. And none of those shares were not incentive options. He however, owns 100 million shares, split adjusted, and obviously cannot even sell 10% of that in one shot. That's why he is not waiting for Dell to top out before making his move. Neither is management. EXCLUDING EXERCISED OPTIONS AND FORM 144s, management has sold 500 000 shares since Sept.
The figure is much more bigger when 144s are included. (We'll assume that sales of shares derived from options were strictly for the collection of paychecks, and therefore ignore them)
I am not saying that Dell will sell all of his shares. Nor am I trying to taunt any Dell Bulls, which is why I am posting here, on the Dell Bear thread. I have nothing against dell bulls: you can still love your favorite stock a little longer, as it is on its way to 120-130. But please don't turn that love into an obsession, especially one that will cloud your judgement. If you disagree with my arguments, that's fine. I'd love to hear your counter-arguments. But please don't tell me that Dell will go up forever because it is your favorite stock. Even the best investments in the world aren't immune to reality. |
