Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Weakness in Sales
On Tuesday, August 21, Dell (NASDAQ: DELL) reported earnings that didn't please investors. In afterhours Dell was down over 4%, and fell 5.35% the next day. So what happened? Second quarter earnings fell to $732 million ($0.42 a share) from $890 million ($0.48 a share) last year. Excluding one-time items, earnings came in at $0.50 a share, versus an expected $0.45 a share. That sounds like good news right? Well, you can't cost cut your way to profitability forever, and revenue declined to $14.5 billion for the quarter, less than the $14.6 billion expected. If you have been following the PC market, then this wouldn't come as a surprise to you; consumer revenue fell 22% (year over year) to $2.6 billion as the PC market remains extremely weak. This is why Dell is trying to shift away from the PC market. Now, the consumer side (PC and laptop) division of Dell is only about 20% of its total business. When the PC market is weak, all major PC manufactures from Dell to Hewlett-Packard (NYSE: HPQ) "race to the bottom" with pricing, which eats into margins and sales. If Dell cuts prices by 10%, HP cuts them by 15%, and Acer cuts prices by 20% and so on and so forth. This is why both HP and Dell have been shifting their focus away from PC's and into services, servers, software, and storage systems. IBM (NYSE: IBM) in late 2004 sold off its PC business to Lenovo Group Ltd in order to get out of the PC business. After the sale, IBM shifted towards more of a service based company like Oracle (NASDAQ: ORCL), which has higher margins and "stickier revenue", as it is a pain to switch to a different company. Both of these companies have been doing really well over the past several years, with Oracle shares up from $26 in the beginning of the year to almost $32 now, and with IBM rising from $184 in the beginning of the year to almost $199 now. To put this in perspective, Dell's stock has fallen from $15 to $11.25, and HP has fallen from $26 to $17.60 in that same time period. My point is that the more service based companies like IBM and Oracle are doing well, while the more hardware based companies like Dell and HP are getting hit hard. A bright spot with Dell was in its enterprise services and solutions division, which saw sales up 6% to $4.9 billion. While I am well aware both Dell and HP are aggressively shifting away from the PC market, they still have a large part of their revenue coming from the hardware sector.
What also really hurt Dell's stock price was its forecast. Back in February, Dell's management forecasted earnings per share of $2.13 for the 2013 fiscal year, but that has now since been pushed down to $1.70, which is 20 cents less than the average estimates from analysts. One discrepancy I saw was how Main Street views Dell versus Wall Street. On the Motley Fool's Caps website Dell gets a rating of 2 out of 5 stars (which points towards an underperform going forward), yet on Marketwatch.com the average recommendation is for an outperform, so Wall Street and Main Street seem to differ on their views of Dell. If you are a Dell shareholder, in the short term one thing you should watch out for is analyst downgrades. Before earnings Wall Street was already guessing that Dell was going to release weak earnings. Now that those earnings were even weaker than expected and Dell's forecast came in well below expectations, expect several downgrades going forward. Now, if you are bullish on Dell but haven't bought in yet or plan on buying more shares, wait for these downgrades and the ensuing drop in Dell's stock price before you get in. No reason to buy high and wait for a turnaround play when you can maximize your returns and buy in lower. In July Dell agreed to buy this company called Quest for $2.4 billion, which makes software that helps corporations manage their computer systems. This helps show investors that Dell is serious about moving into the very profitable services sector.
Tablets and PC's
Microsoft Corp (NASDAQ: MSFT) said that Dell is going to be one of several companies that are going to manufacture their own tablets and run them on Windows 8, which was designed for tablets. Dell predicts PC growth will be very weak for the next 3 years as tablets and smartphones continue to eat up consumers dollars for electronics. Currently Dell is selling the Dell Streak 7 Wi-Fi tablet, which runs on Google's Android system. It didn't get great reviews; on Amazon.com, it gets a 3 out of 5 star rating, and cnet.com gave it 3.5 out of 5 stars. Its new tablet better be packing some serious punch, because so far reviews for Google Nexus 7 are very good, with the Nexus getting a 4.4 out of 5 star rating on Amazon.com, and cnet.com giving it 4 out of 5 stars. Also, Amazon.com is expected to be released the Kindle Fire 2 this fall, which will further increase competition in the already ferociously competitive market. I wouldn't bet on Dell doing very well in the tablet space, but on the plus side, it only has market share to gain. IDC, a 3rd party research firm, is expecting that total tablet sales will double from 107.4 million this year to 222.1 million in 2016. IDC earlier in the year expected the PC market to grow at a 5% clip, but now sees that coming in at a much lower pace of 0.9%. In IDC's June 19 press release they stated that "Windows 8 could help to reinvigorate a consumer market that has lost a degree of enthusiasm in recent years", which is what is going to power the PC growth. Now personally I think tablets will sell much better than expected and that PC sales will remain weak until we see a pickup in the US labor market and global growth above 4%. Plus, a big part of the PC markets success is based on how well consumers take to Microsoft's revamped OS platform. If IDC is right, expect continued weakness in Dell's PC business.
Growth for Dell?
Where Dell is growing is in its server and networking business, which saw 14% growth. As I said before, their enterprise and solutions and server business saw 6% growth, and now is 1/3 of their total revenue, which is bigger than their consumer division. This is the division they have most of their focus on and several of their acquisitions helped them gain more ground in this space. In the second quarter, they closed the deal for both Wyse (cloud computing) and SonicWall (firewalls and cyber client protection). Another big part of their growth comes from services, which "continues to deliver solid results. Business grew 3% to $2.1 billion driven by 7% growth in support and deployment and 35% growth in our security business. - Our Services backlog increased 5% with balanced growth in contracted services and extended warranty" (from their earnings call transcript). Dell wants to be a one stop shop for companies and corporations, where you go to them for servers, cloud computing, security and other services, plus computers. Dell has been aggressively taking up market share in the server sector; last February Dell has 14.8% of the total market share, up from 13.1% a year ago, according to Gartner (another 3rd party research company). One of the reasons for this share grab was gains Dell had in the x86 processor market, where its share grew from 22.1% of total sales to 23.4% in a year. Watch Dell's server division, it has room to grow and is doing very well. HP's service division didn't do so well in its latest quarter, so that is a little disconcerting. Recently, Dell hired ex-HP executive Marius Haas as their next new president of enterprise solutions, replacing Brad Anderson, to try and spur more growth in this area. Marius has a fair amount of experience in this area, so it will be interesting what he brings to the table.
One catalyst for Dell in their consumer division is the back to school shopping season. When people enter college, a lot of them need a PC or laptop nowadays. According to the US Census Bureau, "19.7 million - The projected number of students enrolled in the nation's colleges and universities this fall. This is up from 14.4 million 20 years ago". This is a very bullish trend, as more PC's will need to be sold, because in 2010, 89% of students had a computer, with half of those less than a year old (from EDUCAUSE). In 2005, according to Market Data Retrieval, there were 14.2 million PC's for classroom use, which is about 1 per 4 students, up sharply from the 1 per 63.5 students in the 1984-1985 school year, and a big improvement from 1 per 6.3 students in the 1997-1998 school year. If this trend continues, more students in K-12 will mean more PC's need to be sold, just as more college students means more PC sales as well. While this is just a small part of Dell now, it could help the struggling PC market.
Dell is more than just a PC maker, it has a strong service sector, is doing well in the sever market, and is expanding its cloud services. Many have the stigma around companies like HP and Dell that they are just hardware companies, when is reality they do much more than that. Dell will continue to diversify itself and try to "pull an IBM" and get a better footing in the very lucrative services market. The problem with the services market is getting the clients, but once you get the client, that’s very sticky revenue with high margins. Dell is a possible turn around play; now while there probably won't be any significant improvement in the PC market, if they continue to expand their IT services, Dell could turn itself around and reserve its slide.
callumturcan has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines, Microsoft, and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.