How Long Can Dell Defy Gravity?
JANUARY 15, 2002
STREET WISE / BusinessWeek Online
By Andrew Park
After discounting lifted the computer maker's market share -- and stock, analysts are now dubious about further, short-term growth
Few tech companies have weathered the recession with more poise than Dell Computer. Faced with the worst slump in the PC industry's history, Dell took advantage of its low costs and slashed prices. That helped it gobble up market share, while layoffs and cost cutting kept it comfortably profitable. To investors, Dell (DELL ) has remained the star of the PC stocks.
Can Dell continue to defy gravity? Corporate spending on technology is in a deep rut, and no one expects it to climb out until the latter half of 2002 -- at the earliest. And when demand does rebound, it's unclear if customers will want to buy new PCs, rather than storage drives for backing up data or efficiency-boosting software. That could keep sales and profits stalled. Many analysts think Dell stock, which closed at $28.18 a share on Jan. 14 and has soared 80% since Sept. 21, has nowhere to go but down. "The next six months, it's going to be tough to get the shares north of $30," says Prudential Securities analyst Kimberly Alexy.
Even so, Dell expects its growth engine to chug along just fine, thank you. While the economy has taken a bite out of growth -- net income is down 36% and sales 10% -- the company expects to continue to outpace competitors. And if it can increase sales of servers, storage gear, and professional services, which now account for 19% of total revenue, and sales abroad, which make up 30% of revenue, Dell can win back some of the profits it gave up during the past year's price war, executives say.
WAITING TO UPGRADE. Dell-watchers, many unnerved by the company's willingness to trade margins for market share, aren't so sure. Thanks to intense discounting on all its products, the company's average selling price fell 16% from 2000 to 2001. That dropped its gross profit margin to 17.6%, from 21.3%. And Dell expects to keep pricing aggressively until demand improves.
As the industry rebounds and parts prices stabilize, Dell executives think prices will rise. But historically, once computer prices have fallen, they've stayed down. Says Technology Business Research analyst Brooks Gray: "The average sales price doesn't go up."
Gray says that means Dell will have to continue to dramatically increase its sales volumes just to meet revenue expectations. And the heady levels of 1999 and 2000 are out of reach, he adds. All that price-cutting didn't revive sales of PCs, which likely will decline 4.3% in 2002, or servers, which will grow just 5.2%, according to estimates from Gartner Dataquest.
Dell executives are hopeful that buying will pick back up when economic conditions improve and loosen corporate purse strings. And Dell CEO Michael S. Dell says companies should start upgrading older computers by spring, especially those bought in 1999 to prepare for Y2K. He estimates that 450 million computers are running processors slower than 700 megahertz -- a snail's pace compared with 1.5-gigahertz models now selling for less than $800. Says Dell: "There's a misperception here that nobody's buying computers."
GERIATRIC CHIPS. Perhaps. But researchers say cost-conscious computer buyers are stretching the life of their PCs, in part because most applications will run on older, pokier models. That will slow long-term growth of PC sales to just 3%, according to a report released by Credit Suisse First Boston on Jan. 3.
And even if PC demand roars back, Dell might struggle to revive growth. Last year, instead of waiting for demand to recover, it stole customers away from rivals by being the first to pass along falling component prices. But those cost declines are slowing, blunting Dell's edge. Meanwhile, it's not clear that Dell can continue to reduce operating expenses, another way it fueled the price war.
After shrinking to 10.5% of revenue in 2001 from 11.5% in 2000, those costs will level out around 10%, analysts estimate. Meanwhile, rivals are focusing on their own efficiency in a bid to close the gap with Dell. Says C.E. Unterberg Towbin analyst James D. Poyner: "Dell will run out of the ability to radically gain share."
WAITING FOR GROWTH. All of which makes Dell look pricey at its current 41 times earnings for fiscal 2003, which begins Feb. 1. Until demand returns and companies begin upgrading PCs in droves, adds Prudential's Alexy, profit targets won't be raised. That will keep the stock from jumping. "The growth has to come back," she says.
With the industry's best business model and most consistent execution, Dell is both a leader in PC stocks and, according to Alexy, the long-term victor. But if you're looking for stellar growth in the near term, picking this winner probably won't get you what you need.
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Park is a BusinessWeek correspondent based in Dallas
Edited by Beth Belton |
