Downsouth, Dan Niles interesting comments on the four horsemen in Dell report.
We were talking about an opinion that DELL has no real
product differentiators, no intellectual property, and is vulnerable to competition....
You weren't reading from the (in)famous Dan Niles, Robertson Stephens report on Dell from yesterday, were you? Reason I say this is, he mentions that Dell is considered one of the four horsemen of the Nasdaq, and this helps warrant their high valuation. But, he says that if their earnings are going to slow, which he predicts, then their PE should come down some. Goes on to say that, because they don't have the differentiators (get that word from me?;-)), IP, etc., like Cisco, Microsoft and Intel, their PE should be discounted more. So, if the d and the IP aren't there for Dell, and their PE should go down, but they are there for the "three horsemen", then their PE's should stay the same, or, what the hell, go up. Right? Mentions all this three fourths of the way down the long report (bold). The three horsemen bit is mine. Cheers.
DELL: Believe revenues light as competition intensifies but EPS in line...
01:43am EST 12-Feb-99 BancBoston Robertson Stephens (Niles, Daniel)
February 12, 1999
D E L L C O M P U T E R
Believe revenues light as competition intensifies but EPS in line;
Believe multiple will contract with growth rate -- $80 Price Target
FYE: Jan 1998A 1999E 2000E
EPS: 1Q $0.13 $0.22 A $0.31
2Q $0.15 $0.25 A $0.33
3Q $0.17 $0.28 A $0.36
4Q $0.20 $0.30 E $0.41
FY EPS $0.65 $1.05 E $1.40
P/E 156.0x 97.2x 72.5x
CY EPS $1.01 $1.37 NM
CY P/E 100.4x 74.3x NM
Revs ($M): 1998A 1999E 2000E
1Q $2,588 $3,920 A $5,797
2Q $2,814 $4,331 A $6,318
3Q $3,188 $4,818 A $7,108
4Q $3,737 $5,468 E $8,046
Year $12,327 $18,537 E $27,269
MktVal/Revs: 10.4x 6.9x 4.7x
Key Points:
** We believe Dell's finish to the quarter was soft, leading to revenues of
$5.2 billion relative to our $5.5 billion expectation. During Q4, we
believe that the competitive pressure intensified, especially in the
corporate market. We believe as a result that units came in at about 2.2M
versus our 2.3M expectation and 2.0M in Q3. We believe that most of the
shortfall came from U.S. corporate desktop and server revenues. We believe
that this region was about $3..5 billion in revenues versus our $3.7 billion
estimate and $3.4 billion last quarter.
** We believe that corporate ASPs are under pressure even though component
costs are firming. We believe ASPs ticked down slightly from $2355 in Q3 to
at least $2350 in Q4 versus our expectation of $2375. We believe that more
direct selling by competitors combined with competitive products will force
ASPs further down in coming quarters. We believe that better expense control
and margins enabled the company to reach consensus EPS of $0.31. Given its
phenomenal growth in the last 3 years, we believe Dell has plenty of
reserves available to accomplish this.
** Given our revenue expectations, this would imply that y/y revenue growth has
slowed from 66% in July 97 to 54% in July 98 to about 39% in January 99. If
the growth rate, however, is slowing down from the 50s to 40s, we believe
that the multiple is likely to follow suit with a 20% contraction from 50x
to 40x for CY00. We therefore are establishing a $80 price target for Dell
in the near term.
RATING: MP
SUMMARY:
We believe Dell's finish to the quarter was soft leading to revenues of $5.2
billion relative to our $5.5 billion expectation. We note that consensus
expectation are between $5.4-$5.6 billion. During the quarter, we believe that
the competitive pressure intensified especially in the corporate market. We
believe as a result that units came in at about 2.2 million versus our 2.3
million expectation and 2.0 million last quarter. We believe that most of the
shortfall came from US corporate desktop and server revenues. We believe that
this region was about $3.5 billion in revenues versus our $3.7 billion estimate
and $3.4 billion last quarter. Consumer seems to have done well even though the
competitive environment here also seems to have intensified.
We believe that corporate ASPs are under pressure even though component costs
are firming. With regards to ASPs, though the company is benefiting from the
firming of component prices, due to the competitive environment we believe ASPs
ticked down slightly from $2355 in Q3 to about $2350 in Q4 versus our
expectation of $2375. We believe that more direct selling combined with updated
products by competitors (versus the old inventory being cleared in 2H:98) will
force ASPs further south in coming quarters.
We believe that better expense control and margins enabled the company to reach
$0.31. We believe that a sequential increase in gross margins to about 23%
from 22.5% last quarter combined with better-than-expected expense control has
enabled them to reach the consensus estimates of $0.31. Given the phenomenal
growth seen by the company in the last 3 years, we believe the company has
plenty of reserves available to accomplish this.
Though we believe that Dell's business model is still the best in the industry,
we believe that growth is slowing for Dell given flattening component costs and
increased direct competition. Dell has proven the superiority of the direct
model over the last year as it has prospered with record margins while much of
the industry has suffered with breakeven profitability primarily due to
inventory and pricing issues. During most of 1998, Dell benefited especially
from the sharp declining in component prices (due to its direct business model)
and its competitors clearing out-of-date channel inventories. Note that
component prices in general declined rapidly in 1998 as excess PC inventory led
to little component demand for most of the year. However, with component prices
firming in late 1998 and continuing into 1999, we believe this will result in
much less of an advantage for Dell versus the industry. In addition, the
indirect vendors have reduced their channel inventory down to only 3-5 weeks
from 10-12 weeks in late 1997, drastically shrinking the direct model's cost
advantage. The aggressive push in direct and online sales by the other
indirect vendors, especially Compaq, will no doubt accelerate competition in
the direct segment of the PC market in the future.
We also believe that the corporate market is getting much more aggressive. IBM
(IBM $179), in particular, seems to be turning up the heat at some major
accounts. Our sense is that they are starting to worry that the loss of
hardware market share may be affecting their services, support and software
business. Compaq (CPQ $45), also with a higher-margin service business
starting to ramp, is also getting more aggressive on bundled hardware pricing.
We therefore are establishing a $80 price target for Dell in the near term.
Given our revenue expectations, this would imply that y/y growth has slowed
from 66% in July 97 to 54% in July 98 to about 39% in January 99. Given our
belief that Dell is currently perceived as one of the four horsemen of the
technology industry, we believe that one can justify that the company deserves
a multiple consistent with its growth rate. If the growth rate, however, is
slowing down from the 50s to 40s, we believe that the multiple is likely to
follow suit with a 20% contraction from 50 to 40x for CY00. We therefore are
establishing a $80 price target for Dell in the near term. We would also argue
that given the more competitive and less differentiated nature of Dell's
business relative to that of Cisco (CSCO $105), Microsoft (MSFT $163) or Intel
(INTC $133) that a discount to the growth rate might be more appropriate. To be
clear, we believe the company will not miss our $1.40 EPS for CY99 but 34% EPS
growth following 60% EPS growth in CY98 we do not believe will support the
current multiple.
Exhibit I: Comparables
Y/Y Latest Quarter Y/Y Growth P/E
Price Appr. Revs EPS Revs EPS TTM CY 99 CY00
Dell $ 101.88 268% $4,818 $ 0.28 51% 65% 107.2 69.3 50.9
Intel $ 133.25 57% $7,614 $ 1.19 17% 21% 37.6 28.4 24.2
Microsoft $ 162.75 105% $4,938 $ 0.73 38% 74% 71.1 60.5 50.1
Cisco $ 104.88 141% $2,827 $ 0.36 40% 24% 79.5 64.3 54.1
Dow 9363.46 12%
Nasdaq 2405.55 40%
Source: BRS
THE COMPANY AND INVESTMENT THESIS: Dell is a leader in direct marketing of PCs.
The company's foundation is in sales of custom-built PCs with competitive
pricing. Today, Dell continues those efforts, with sales of desktop, mobile and
server products. Dell's desktop and server sales are all completely built-to-
order -- the product is not even begun until the customer has placed the order,
and the order has been verified. This results in high inventory and asset
turns, and good profitability, in a market where profits have at times been
elusive.
Moving out over the next two years, the installed base of commercial systems
will likely go through a complete retooling as corporations move from legacy
mainframe systems to a more price-competitive client/server environment. With
the delivery of Windows NT 4.0 during the fall of 1996, the market saw the
delivery of a high quality competitor for the many varieties of UNIX that have
been around for so long and have garnered so much share of the workstation
marketplace. When NT is married with a Pentium microprocessor, the result is a
low-price, low-cost computer with competitive performance statistics, ready to
rival the installed base and new applications for workstations. We remain
cautious on Dell given its high valuation of 50x CY99 EPS, firming component
costs, and increasing competition from indirect vendors in the direct market.
INVESTMENT RISKS: Among the risks are the cyclicality of the PC industry,
brought on by historical inventory builds followed by massive price erosion as
companies slash prices in an attempt to reduce inventory overhangs. In
addition, the PC industry has at times been plagued by component shortages,
causing companies like Dell to have to pay more to get the components required.
These times have caused for deterioration in the gross margins of the PC
companies, as they have for the most part been unable to pass the cost
increases along to their customers. Overall PC demand can also be a risk, as it
could lead to increased pressures as companies work to hold on to market share
or worse try to hold unit shipments level so that overhead can be better
covered. This can create times of significant oversupply. When coupled with the
rapid technological changes of the PC industry, any inventory held can lead to
losses as product transitions make that inventory obsolete rather quickly. |
