Tag Archives: Dell

My Take on Dell Case Study

Dell Big

We first spoke here of Dell http://wp.me/p2OaYY-1G2

Dell Case Study

So begins my analysis of Dell. Please be aware that I have been a recent shareholder of Dell, but no longer own shares. These comments should be taken in context of potential self-serving, hindsight bias.  My methods may or may not be applicable to your investing, but I will lay out my assumptions.

First, I look at Dell_VL_2013. I love Value-Line for all the historical information that it packs into one page. However, I use it for a first screen and as a tickler to focus my reading when I go to the proxy and annual reports. Next, I go to the history of Return on total capital (“ROTC”) and ROE. In 2002 Dell had almost a 40% return on total capital averaging close to 50% until the plunge down to 17% in 2009—not unexpected given that computers could be considered a capital good. Use of debt was minimal.

My eye notices that ROTC has not really recovered to the pre-2009 glory days and now averages about 14%, a normal return on assets for an average business. Having read about Dell over the years, I know Dell had a business process advantage. Dell had a lower cost structure in computer assembly and distribution over its competitors. If you go to www.hbs.org you can download dozens of case studies on Dell’s manufacturing advantage. The market and competitors changed. Dell lost its cost advantage RELATIVE to its competitors. Now Dell is a commodity business. The proof lies in the history of its ROTC.

Next, I see sales growth per share about quadrupled from 1996 to 2000 during the Internet boom/bubble before flattening out at a ten-year 5.2% compounded annual growth rate from $35 billion in revenues in 2002 to about say $57 billion estimated in 2012. Wow, a big sales deceleration.

Dell has been buying back shares continually since 2001 both to sop up option issuance and shrink share count. My eyeball says management started shrinking the share count by 900 million shares from 2001 at an average price of $25—almost 90% above Dell’s current $13.65 offer. Dell’s management spent roughly $22.5 billion on share buybacks. The shareholders who remain sit with a current market cap at $24 billion (1.73 billion outstanding shares times $13.7 current share price). The shareholders who sold are the ones who benefited while the long-term and long-suffering shareholders saw the firms capital squandered.

If Dell’s management destroyed capital buying their OWN company, what does that say about their ability to make acquisitions outside their area of expertise going forward? I wonder….?

I jump to Dell’s proxies:2012 Dell Proxy and 2010 Dell Proxy. Michael Dell already owns about 13% of Dell which I don’t begrudge him since he did create the company and develop a better way to assemble and distribute than his competitors, for a time.

But why does he receive a dollop of 500,000 options every year? How does receiving more options incentive him more than his 13% stake and on top of his generous salary?  My prejudice is that Mr. Dell looks out for number one first and shareholders second.  I think Dell comparing itself to Intel in its peer group is absurd. Intel has to spend much more on R&D, for example, than Dell. They are different businesses. Dell’s compensation plan has the makings of fancy consultants. Read more on M. Dell’s compensation: http://www.footnoted.com/perk-city/dells-tale-of-two-proxies/

For a brief history but biased slanthttp://www.motherjones.com/politics/2011/02/michael-dell-outsourcing-jobs-timeline

Dell Michael

Now from Dell’s 2012 Letter to Shareholders Dell Sh Letter 2012:

I’m proud to report we delivered on that promise in fiscal year 2012. We made big investments to expand our portfolio of solutions and capabilities and to build an expert global workforce to deliver them to our millions of customers. By the end of the year, enterprise solutions and services accounted for roughly 50 percent of gross margins—a record result, and great validation that we’re on the right road and delivering the technology solutions our customers need.

I am excited about our future. Information technology is a $3 trillion industry, and we currently have roughly a two-percent share. The opportunity to grow and, more importantly, to help our customers achieve their goals is tremendous. That is—and will always be—our ultimate goal.

That ladies and gentlemen is called the “Chinese Glove Theory.” If I can garner 1% of the Chinese Glove market by getting 1% to 2% of the 2 billion Chinese to wear one glove (like Michael Jackson), we will be rich.  Of course, what edge do I have and/or profits will be made doing that relative to competitors?

Ok, Dell has made big investments to grow but how does Dell have a competitive advantage in any of its businesses? If I can’t answer that question—and I can’t—then Dell’s GROWTH has NO value, zilch, nada, none.   Returning money via dividends and share purchases is good provided the company shrinks itself faster than the decline in its business or does not squander its cash with overpriced acquisitions or share buybacks.

Note the average annual P/E ratio has moved down from the hyper growth 62 P/E in 1999 all the way down to the current 6 or 7 P/E net of cash. High expectations have collapsed to low expectations. Good, I seek low expectations.

Also, note the wisdom of crowds (the market). See the dotted line showing Dell’s share price relative to the market that declines from the end of 2002 to today. Note the decline accelerating while Dell made a high of $42.60 during 2005. The market (like it is doing with Apple today) was and is handicapping Dell’s future prospects. The “market” sensed the change in competitive dynamics occurring in Dell’s business. Respect the market because the onus is on you to be right or contrary to the consensus.

So what is the business worth? 

Post tax “cash flow” is about $1.90 per share.  Capex is estimated at 30 cents per share, but it was 38 cents per share in 2011 and back in 2006 and 2007 almost 40 cents.  I want to err on the side of conservative so I put 40 cents for capex.   $1.90 per share in “cash flow” minus 40 cents leaves me about $1.50 in free cash flow (“FCF”).  For a discount rate with NO GROWTH I use about 11% to 12% because that rate is the average equity return for an average business. Yes the 30 year bond (“risk-free”) rate is 4% but normalized the rate is closer to 6% or 7% and I think historically the equity premium has ranged much higher (go read The Triumph of the Optimists for a history of equity premiums by country).

$1.50 divided by my discount rate of 11.5% leaves $13 per share for the operating business. The excess cash is $11.3 billion in cash minus $5.3 billion in long-term debt or $6 billion in net cash or about $3.50 per share.  But I can’t get my hands on that cash, and taxes would have to be paid to repatriate that cash—I will knock off 25% and use $2.50 to add back to my operating value. I see that total debt is $9 billion so I need to check out the terms of the debt, but I will use $2.5 per share to add to $12. 50 to $13 per share operating business value with no growth of $1.50 per share FCF using a 11% to 12% discount rate.

My back of the envelope value is $15 to $16.5 per share. Now, that value range assumes no growth but also no decline. I am receiving about 4% per year of the $1.50 in free cash flow in dividends and share buybacks. On the other hand, I have Mr. Dell’s high compensation, poor capital allocation record on share buybacks, and “me-first” attitude towards shareholders.

Since growth has no value, I am buying a non-franchise type company. Profitable growth will not bail me out, so I need a 30% to 40% discount for my margin of safety AND I can’t make it more than 2% to 3% of my portfolio. A major position for me is 5% to up to 15%. 30% to 40% discount from $15 to $16 leaves me a buying range of about $9 to $11. I will be conservative and look at $15 as my level of value so $9 to $10.50 will be my range. I bought in Sept. 2012 at about $10.60 and again in November at about $9.15 for an average price of $9.80.

Dell small

Yes, I could be making all this up with hindsight bias, but this is from a simple man.

Upon the announcement of Dell going private, I waited a day and sold at $13.55. Why sell when the minimum value I placed on it was $15 and up to $16 per share?  I am not an arbitrageur. I will leave it to them to make the last nickel or dollars.  The business seems cheap, but I ride with a poor capital operator in a commodity business. I don’t see much future value and perhaps I was TOO AGGRESSIVE in my valuation. My return for investing in Dell is 39% for six months. Good, but it doesn’t factor in my losses for when I buy a “Dell” and all hell breaks loose and I may have to sell at $5 or $7. But I had excess cash, free cash flow, shareholder angst (Pzena and Southeastern) and LOW EXPECTATIONS at my back. My expectations of management and the business were low as well, but perhaps not low enough. Time will tell.

If you read Southeastern’s letter Dell-Board-Letter_by_Longleaf, they place a value of $24 on Dell (Southeastern paid about an average of $25 for Dell’s stock over the past five years (see 13-FH filings).  They mention Dell paying about $12.94 per share at cost for their acquisitions buttressed by Dell’s CFO saying to that point had delivered a 15% internal rate of return.  Perhaps, but I am skeptical that Dell’s acquisitions will generate more than an average rate of return.  What does Dell bring to the party in its acquisitions? Scale? Technology, Patents? Customer captivity? Ironically, if Dell isn’t worth at least $13 per share for those acquisitions, then Dell’s current bid is another nail in the coffin for its reputation in building shareholder value.

I do agree with Southeastern’s letter that Dell should allow shareholders the option to remain invested in the company if they so choose while breaking up the company.  If shareholders have traveled this far, let them decide.  Basically, Michael Dell wants to use more cheap debt (available today) as a tax shield to juice his after-tax returns.  I don’t blame him, but let the shareholders decide.

Beware of sum of the parts valuations. If you do use them, analyze the competitive advantages of each business segment.

I could spend a year on Dell reading about their divisions but I would have no edge over industry analysts. My edge (I hope) is sniffing out despair with a cynical eye.

Dell is not an obscure, forgotten company/stock, but it was laden with disappointment, despair and low expectations. I just had to wait for my price or walk away.

Hope this helps you to find our own way.


UPDATE: FEB. 12, 2013:

Mason Hawkins Buys More Dell While Opposing the Deal

The future of the Dell (DELL) deal is looking dimmer as its largest outside investor Southeastern Asset Management buys more shares while openly opposing the deal. Southeastern Asset Management bought almost 17 million shares in the past weeks. It now owns 146.8 million shares, which is about 8.5% of the company. Southeastern Asset Management has openly opposed the Dell deal, which is led by Michael Dell and plans to buyout other shareholders at $13.5 a share. Southeastern Asset Management said that the deal “grossly undervalued the company,” and believes that Dell is worth $24 a share, according to Barron’s.
Southeastern Asset Management has been a long-term holder of Dell, and started buying the stock when it was trading at above $30. Its average cost is estimated to be above $25. If the deal went through at $13.5, Southeastern would have lost almost 50% of its original investment, excluding dividends.

I will be out until Friday………until then.



LBO List Search Strategy

Highlight Reel

All corporate growth has to funnel through return on equity. The problem with growth companies and growth countries is that they so often outrun the capital with which to grow and must raise more capital. Investors grow rich not on earnings growth, but on growth in earnings per share. There is almost no evidence that faster-growing countries have higher margins. In fact, it is slightly the reverse.  (CHINA!)

For there to be a stable equilibrium, assets, including entire corporations in the stock market, must sell at replacement cost. If they were to sell below that, no one would invest and instead would merely buy assets in the marketplace cheaper than they could build themselves until shortages developed and prices rose, eventually back to replacement cost, at which price a corporation would make a fair return on a new investment, etc.

The history of market returns completely supports this replacement cost view. The fact that growth companies historically have underperformed the market – probably because too much was expected of them and because they were more appealing to clients – was not accepted for decades, but by about the mid-1990s the historical data in favor of “value” stocks began to overwhelm the earlier logically appealing idea that growth should win out. It was clear that “value” or low growth stocks had won for the prior 50 years at least. This was unfortunate because the market’s faulty intuition had made it very easy for value managers or contrarians to outperform. Ah, the good old days! But now the same faulty intuition applies to fast-growing countries. (www.gmo.com  4th qtr. 2012 letter)

Value Investing News and Links

Don’t forget to go to www.grahamanddoddesville.com and www.santangelsreview.com for their FREE value investing news emails. I would immediately go on a suicide watch if they ever stopped sending me their great links. SIGN UP! Oh, and visit their blogs as well. Both writers are thoughtful observers of the investment world.

10,000 hours: https://www.santangelsreview.com/2013/02/03/10000-hours-of-deliberate-practice/


Charlie Munger: http://www.marketfolly.com/2013/02/notes-from-charlie-mungers-daily.html

Baupost Letter Summary: http://www.institutionalinvestorsalpha.com/Article/3152364/Baupost-Navigates-a-Tough-Yet-Still-Profitable-2012.html

Where Are We Now?  Ebullient

Shall We Dance Now: http://www.hussmanfunds.com/wmc/wmc130211.htm



Don’t forget the trade cycle: http://www.forbes.com/sites/michaelpollaro/2012/04/27/the-bernanke-bust-the-why-how-and-when/

An Excellent Book on the Trade Cycle (Prepare for the Bernanke Bust to Be….could be a month or years?) Austrian Trade Cycle

Why the real economy is so feeble: An economy built on an illusion is hardly a sound structure



Note what Einhorn says about Apple’s excess cash.  Note also that the junk bond market is ebullient, so as night follows day, expect some buyouts–LBOs or MBOs (Dell). One search strategy might be to find companies with steady free cash flows and strong (underleveraged) balance sheet and wait ahead of the buy out announcements–owning a group of 5 to ten names.

Grant’s Feb. 8, 2013 issue quotes Bloomberg on Jan. 31:

With exclusive brands that help build customer loyalty and a FCF yield that is higher than the median of its peers, Kohl’s could be an attractive buyout candidate for a private equity firm…..The company’s real estate also adds to its appeal…. Kohl: KSS_VL 2013

But I think Coach (COH) is an even better candidate: COH_VL_Feb 2013 with its higher, more consistent returns and excess cash.

Build your list because Mr. Ben Bernanke wants the $360 billion in committed unspent capital dedicated to buyout funds (Bloomberg estimate) to be spent.  Source: www.grantspub.com

Then sit back and ….lobster or the cracked crab?





Case Study on Dell

Least Resisitance

Dell Case Study

Stop the presses! Before reading Longleaf’s valuation of Dell (linked below), go to the 2009 and 2013 Value-lines and value Dell with a back of the envelope calculation using a post-tax free cash flow yield as one signpost.

What do you think Dell is worth—about?  What do you think of the valuations mentioned in this article? Does growth have value? Why or why not?

Do you have any criticisms?  What in Michael Dell’s prior history makes you (perhaps) not surprised by his current actions? Would you have factored that into your pre-announcement valuation?  How?  Should Dell offer to do a Tender Offer for the shareholders?  If the price callapsed to $9 or $10 based on the deal being pulled what would you do?

Case Study Materials: Dell_VL_2009     Dell_VL_2013   Dell_Valuation_and_Tender_Offer_Case Study

Longleaf Protests: Dell-Board-Letter_by_Longleaf

DELL_Morn: Background on Dell

I will put in my two cents next week in the comments section.  Email prizes awarded.

Update Feb. 11, 2013: Corporate BS: http://covestreetcapital.com/Blog/?p=828


Common Sense Words about America (not political)

 See what independent thinking, love of history and knowledge plus GUTS can do…..

The Actual Speech: