DELL Analyst Meeting: 4/9/99 (Part 5, Cowen Securities)
08:37am EDT 9-Apr-99 SG Cowen Securities Inc. (CHU, RICHARD) DELL
DELL/SOME POST-MEETING THOUGHTS: DELL REASSURES/BUY
...
Dell Computer (DELL - $45)
Rating: 2/BUY
SOME POST-MEETING THOUGHTS: DELL REASSURES; BUY
EPS (FY Jan) Quarterly EPS
Jan New Old P/E* Q1 Q2 Q3 Q4
F98/C97 0.32 0.07 0.08 0.09 0.10
F99E/C98 0.53 0.11 0.13 0.14 0.16A
F00E/C99 0.75 60X 0.16 0.17 0.20 0.22
F01E/C00 1.00 45X
2.76 Billion shares; $125 Billion Mkt. Cap.; TTM Revs. = $16.8Billion
Key Points:
1. Dell reassures investors re aggregate dynamics; Q1 in good shape.
2. Talking a lot more about "services".
3. Strong enterprise/server/storage momentum (see yesterday's notes);
attacking Compaq.
4. Consumer: will sell cheaper PCs profitably; our read: business
models continue to change here.
5. Maintain 2/buy; Dell is our top PC pick; but, would not be
aggressive here.
Investment Thesis - Dell remains our top pick in the PC systems sector;
specifically we think that Dell possesses a sustainable competitive
business advantage stemming from its direct model, especially as it
aggressively leverages emerging internet and e-commerce infrastructures.
In contrast, major indirect competitors are likely to continue to
struggle with model re-engineering, constrained by existing channel
relationships. That said, we are generally cautious about PC stocks and
continue to feel that the PC demand picture in 1999 will be peculiarly
difficult to characterize with a number of intersecting cross currents
stemming from the confluence of factors: demand (Y2K remediation,
Windows 2000), rapidly evolving competitive business models, especially
at the low-end, and flat to rising component costs. Our 12 month price
target, assuming 50X C00 EPS, is about $50.
Detailed Discussion - Since we made some preliminary comments with
respect to DELL's enterprise business yesterday, we will not repeat
those here.
DELL REASSURES INVESTORS. Although as always there was no specific
guidance, management made enough reassuring comments with respect to the
current state of business, the net of which, as we suggested yesterday
morning, is that investor expectations coming out of the meeting for
April Q1 results are likely to tighten, rather than widen, around a
$5.45+B (+6% sequential, we are a tad higher at $5.5B) and 16c
consensus. At the end of an unusually quiet and buzz-free morning
session, Tom Meredith, Dell's CFO and the customary closing speaker at
these types of sessions, closed with an expected bullet point: "Strong
business across all geographies, product, and customer segments." We
take this to mean that Q2 is indeed in good shape.
Viewed alternatively, and recapping comments we have made on this point
over the last several points, it is Dell's perception that end-demand
has not changed meaningfully one way or the other and that the
downs-and-ups reported by major competitors (mostly in the indirect
arena) are reflections of exacerbated seasonality, product shift (e.g.,
P2 to P3) and channel issues. This is certainly not an unreasonable
view; however, we haven't changed our view that there will be a number
of forces, as 1999 plays out, that are likely to make aggregate
conditions tougher than normal for the PC business --- these include, in
no particular order: Y2K replacement bubble (or absence thereof) and H2
lockdowns in large corporates, the absence of broadbased replacement
initiatives from desktop OS cycles; and generally tighter supply/demand
conditions for components (LCDs certainly, DRAM's and drives also) in an
environment which could make it tougher to fund aggressive competitive
pricing.
EXTENDING THE MODEL: PRODUCTIZING SERVICES -- A key new message from
yesterday's meeting was that Dell stood ready to continually evolve its
business model focus from phase 1 (core PC centric) to phase 2 (beyond
the box, with rudimentary services) into phase 3 (emergence as a full
technology partner for the customer, with extended services and
product), even as it drives for higher operational efficiencies by
leveraging the internet. In this vein, management argues that it
currently generates approximately $1.4 billion in services revenues, and
as it extends the profile of its addressable markets in enhanced
services, it has an opportunity to significantly grow its services
revenue stream, without in a fundamental fashion upsetting the balance
of its best-of-breed partnership model. On this point, it went as far
as to outline specific services programs (examples: so-called Notebook
No Fault programs: potential x-hundred $MM; technical consulting;
desktop/workstation response, etc.), generally niche opportunities that
can be productized and best delivered through the existing direct model
enhanced by the web. Plainly, as investors speculate on whether there
will or will not be larger agreements with IBM (beyond the initial
intellectual property/patent/technology/supply agreement), whether or
not a potential deal with Global Services will leave room for Dell is a
consideration. Our reaction: services is clearly an opportunity and
Dell is on the right track provided it sticks with a niche approach; but
the boundaries with service partners are not crisp enough.
CONSUMER MARKETS/CHEAP PCS/NEW MODELS ARE STILL ELUSIVE --- For all the
concern re cheap PCs, Dell has done a remarkable job of growing a
consumer/small business "transaction" oriented business that is
currently at a $3 billion run rate, growing 80%/annum over the past two
years, delivering about "average" profitability (within Dell) and
essentially infinite ROIC (low inventories, credit card receivables,
hence negative working capital). So far, and it looks like for the
foreseeable future, Dell will continue to address segments of the market
who are "direct model" sophisticates and hence ASP's, even at the entry
level, have moved gingerly, down from the sub $2K area to only very
recently a $999 333Celeron product (with monitor and 3 year warranty).
Dell's fundamental argument is that it has made sure to make money in
this segment, and, going forward, it believes it can make money with
lower price points (presumably, not $399, but say, $799 by yearend) due
to lower component costs. More interestingly, it disclosed that the
contribution to consumer PC gross profit from "non-system items" ---
i.e., sales of other products (printers), financing, ISP bounties, etc.
- rose from 31% of the the total spread a year ago to 38% now. The
question of course is whether this is going to 100% or more: we assume
that certain competitors in fact are already at the 100%+ level
(subsidizing PC sales with anticipated downstream offsets - whether
these do or don't materialize is still speculative). Dell
acknowledged that the non-systems profit contribution will lift, but
fundamentally suggests that there is a lot of trial and error and that
most models are "experimental" at this stage, which is consistent with
our view that the industry has generally not come to settle on an
asymptotic stable business model for this arena. Indeed, we were
disappointed, generally that there was little further fleshing out of
the potential business model dynamics for Gigabuys. Com and the way in
which it would interact with the systems business model (although as we
noted yesterday, management confirmed that Gigabuys would be linked,
quite logically, with the corporate Premier pages offering in the very
near future).
Bottom line: Dell looks formidable in the consumer space, appears ready
to take entry price points down, but relatively gradually over the
balance of the year, is very focused on profits, although the balance
points between profits from sale of the PC and other revenue streams is
unclear; the risk here is not Dell but competitive models.
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