Here is something posted on The Motley Fool (www.fool.com). They have a Dell message board, but they also have one called dueling fools. About 8/7/99 they had a debate on whether DELL was going down or not. R. W. Blair had a great post on DELL. The link is boards.fool.com
Here is what R. W. Blair said:
First a little credibility. I first met Michael Dell in 1992 when introduced by the CEO of my then employer, an exclusive Dell customer. I met him a second time in 1995 when I did some consulting work for him. I have been a long investor in Dell stock since 1997, never sold a share (I couldn't buy due to my consulting company's policy's prior ...). My most recent buy, about eight months ago, is up 16%. The only investors--ever--who might have a loss position would have bought between about 1/15/99 and 2/28/99, a time when the stock was indeed overvalued.
My little family of three has seven computers, including two Dell desktops purchased over the internet in the last six months. Three of the computers are palmtops, not yet made by Dell. Two are laptops provided by employers to my wife and myself; both employers do not use Dell.
Finally, I am a corporate executive who specializes in strategy, particularly during turnaround situations.
In a nutshell, I've met the key Dell players; I was once a Dell insider; I have experience with both pro-Dell and anti-Dell philosophies in action; I have a decade of working world experience with PCs as a developer and a user (I took my first programming class in 1979 on a TRS-80);and, most importantly, I know a thing or two about what makes businesses successful and how to realize big gains in market capitalization.
I could wax on with several anecdotes, including: the 50% out-of-box failure rate for the seven Compaq desktops our IS department purchased for my group last month and the fact that Greg Brenneman--one of the best turnaround executives in the US--doesn't want to try to turn around Compaq. However, the issue at hand is whether or not Dell's $97B market cap will become a significantly larger number over some investment horizon.
There are some boundaries. The Corporate Strategy Board in Washington, D.C. performed a study commissioned by Hewlett-Packard to determine if there is a limit to growth. The study found that in 1998 dollars $100B in revenue (their measure of size) seemed to be the boundary after which companies simply could not keep up with the challenges of superior performance. Hundreds of reasons abound, but one way to think about it is that $100B in revenue is about 1% of the entire US economy. At that point you just grow with inflation and / or GDP. So, will Dell grow at 41% per year forever? Of course not. At 40% for another five years Dell will reach the $100B limit (ignoring inflation), for instance.
Many bears like to take this theme and point out that Dell would BE the US economy if it repeated its last 10 years of growth to make us Bulls sound ridiculous. But, as we shall see, Dell does not need to repeat the last ten years to be a good investment.
So, let's say that Dell, who has around 10% of the world PC market, can continue to grow at 30% - 40% for the next five years. Michael says he would like to be 25% of the world market, a market whose size still increases dramatically each year. In fact, the world market would only have to grow at 15% a year during the next five years for a 10% to 25% share increase to produce 40% sales growth for Dell. I would argue that the demand is there. There are 1.2 billion Chinese sharing fewer computers than are in Seattle.
So what about Dell's ability to continue taking share? Compaq, the market leader, is in deep trouble folks (or should I say fools; I'm new to the board). They bought Digital for way too much (this is the company that handed the operating system market to a Harvard drop-out and his bearded pal because they couldn't execute); they have not been able to integrate; they have lost focus on their core business; they are desparately searching for leadership and finding no takers; their quality has been rated "B" (vs. Dell's "A") for two years by most of the PC trade rags; they are losing money; their last ditch attempt to go direct is already upsetting retailers. And the number one issue why Compaq is in deep trouble? They are teaching PC neophytes that computers are a must-have item, and they are investing big money (via their retail network) to educate people on processor speed, RAM, HDD space and access speed ... and how great the internet is. They are investing to create Dell customers. You buy your first computer at Circuit City and try to keep the price low. Your second computer, bought on the internet, has the latest Intel processor, tons of RAM, a fast HDD, a bigger monitor and the fastest modem to the internet you can find. And you buy that computer from Dell.
You buy from Dell because their price will be the lowest for the computer you want as a second-time or later buyer. Dell's price on the best computer's will always be the lowest because they are the highest volume seller of the best components (the latest processors, DRAM chips, etc.) The only way to offer a better price is to be bigger than Dell, growing faster than Dell, have a higher-end customer profile than Dell and to have less than 6 days of inventory. I presume everyone understands why low inventory is a huge cost advantage in an industry where component prices fall 50% every 18 months and demand changes so rapidly (avoiding unsold or firesale boxes). Better still, for we Bulls, Dell's inventory advantage is a virtuous cycle. The bigger Dell gets, the more leverage it has to get suppliers to take inventory risk; the more leverage, the less inventory. Michael's goal remains 0 inventory. While he puzzles how to get way below a week, Compaq struggles to stay below a month. Even three years ago Gateway or Hewlett-Packard might have made a leap to Dell's leverage. Only a colossal screw up in execution could unseat Dell from this cost advantage now. Having met Michael and worked with his senior management, I don't see it. As several bears have pointed out, the direct CONCEPT can be imitated. Dell's leverage with suppliers cannot.
This cost advantage should help maintain margins as well. By the way, Dell just started getting value out of its brand in 1998. I would argue that it will not only continue to be the low cost producer but that it will be able to take the brand price premium Compaq still has the arrogance to charge.
Additionally, Dell's margins should improve due to product mix. How Dell's movement into portables, enterprise computers and peripherals can be construed by the bears as a bad move is beyond me. The fact that Dell slaps four letters on a box is great. They can and do change product mix continuously and at no incremental cost. Right now, they are focusing on growing the higher margin segments of the business faster. They can do this by leveraging their brand (price, quality, customer relationships) across segments and steal share even more efficiently than in plain old desktops. Let's keep going. They are also growing faster in Europe, Asia and South America. I don't know, but I would guess that international margins are higher than US margins (less consumer buying power, etc.) Have you ever bought a Coke in France? When you shift toward higher margin segments, your margin INCREASES!
The ability to change product mix at a moment's notice also helps dispense with the "Free PC" issue. As soon as Dell's direct customer contact informs them (if it does) that customers really want a flat fee per month for a box and internet access, Dell will give it to them: that afternoon. Dell just has to update a web page and the price table behind it. If this segment becomes big and Dell decides to play, what kind of leverage do you think they'll have with the advertisers vs. e-machine? By the way you may have noticed that they already have substantial lease offerings. Most people don't buy them because the present value is negative for anyone with the cash resources to pay up front.
Also, signing up for a 3-year, $720 contract complete with force-fed advertising to get your "free" PC is kind of silly when internet access will drop substantially over that timeframe and the multimedia content you will want to view will require far more than a 266Mhz MMX with 32MB of RAM over a 56K modem with a 14" monitor that doesn't support advanced video. Better to buy a 400Mhz Celeron with 128MB RAM, 6.4GB HDD, 17" Monitor with an 8MB 3D AGP graphics card, DVD-ROM drive with TV out, Harman / Kardon stereo speakers, and next-day on-site warranty for $1,231 or $47 per month (available from Dell right now). You will actually be able to use the internet for something, and you get a DVD player for your TV for "free." My mother-in-law took the e-machine deal. It couldn't open the digital picture I emailed her of her granddaughter.
What does all this mean?
If the market will allow Dell to quintuple its sales; if its competitive advantages are strong and getting stronger (the supplier leverage and demand measurement advantages are really the source of Michael's confident statements about his business model); if these competitive advantages will easily allow Dell to achieve 25% of the world PC market; and, if these same advantages plus product mix shifts should keep Dell's margins strong (with some upside from brand premiums), Dell should be able to produce 30% - 50% earnings improvements each year for the next five.
However, one bearish comment: Dell's multiple should drop. Multiples reflect a present value of a company's earnings forever. Dell's growth rate from 2005 - death of Earth's sun should be much lower than from 1990 - 2005 (although the computer left to monitor the Earth's last days will almost certainly be a Dell). As we get closer to 2005, therefore, the market should rationally start to reduce Dell's multiple.
Let's do a little math. Say Dell made $1.5B in the last twelve months. Say that earnings number grows at 40% per year until 2005. Say Dell's multiple drops from the 65x - 100x range its been in for a while down to 50x. Dell should make roughly $8B in 2005. At 50x that would be a market cap of $400B, or a 32% compounded average annual return on the stock if you bought at today's price (market cap of $97B). For some perspective: $400B is Microsoft's current market cap (the largest in the world), Cisco and Intel are at about $200B. Say Dell only makes it to $200B. That's still a 15% average annual return vs. the lifetime market return of 12%. That kind of return for a company that has one of the strongest combinations of strategy and execution ever.
So, should you buy Dell at today's price? You would be a fool not to. |
