Reinventing Dell
Mohamed is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Dell (NASDAQ: DELL) was a company that was once synonymous with the PC. The company was founded by Michael Dell when he was a grad student in the University of Texas in 1984, it then grew to be the largest PC maker in the world before forking over that title to Hewlett Packard (NYSE: HPQ) in 2005. From 1990 to its 2000 high the stock was a shareholder’s best friend returning a gain of 56,000%!!!
From then on, however things haven’t been quite as rosy. Dell was affected by the dot com crash as were most tech stocks in 2000 and ever since has been in a downward spiral losing 75%. This isn’t a typical Microsoft (NASDAQ: MSFT) or Intel story where a stock suffering from irrational exuberance gets a reality check. Dell has really negative investor sentiment right now. The stock is currently trading at an anemic valuation of a 6.9 P/E and 0.3 P/S compared with an 11.2 P/E and 3.5 P/S for Microsoft and an 11 P/E and 2.4 P/S for Intel.
There are two possible reasons for this:
1) Dell, just like I said, was synonymous with the PC market and the future of the PC market and companies heavily anchored to it is not seen as too bright by most investors.
2) Dell over the last Decade has done a pretty lousy job in the very PC market it's anchored to. Unlike Wintel* who even though has been suffering a pounding over the last few years from the new darlings of Wall Street Apple and ARM Holdings, the company remains dominant in their respective places in the PC space. Windows is still the most used operating system on desktop computers and laptops and Intel is still the largest chip manufacturer.
Dell however has not been able to preserve it's place in the PC world, in fact Micheal Dell decided to return as CEO of the company in 2007 to save it from its downward trajectory.
Now before you call your broker and make that short, you should know that companies can and have reinvented themselves before and recovered from difficult times if they had the right leadership.
Imagine telling someone in 1999 that Apple Computers will be the Nokia of the future, will turn the music industry on its head, will outsell luxury retailer Tiffany per sq foot, and will be the most valuable public corporation on Earth!
That person probably would've said 'what in tarnation are you talking about, Apple is a PC maker that happened to be in financial distress and facing bankruptcy a couple of years ago if it hadn’t been bailed out by its competitor and arch rival Microsoft who so far is wiping the plank clean with Apple and has over 90% market share in OS. And how exactly are they going to outsell Tiffany again, do you mean the Apple section at Circuit City or Best Buy?'
However, All of those things in 2012 are a reality. Apple is the largest corporation in the world with more than half a trillion dollars in market cap, it dominates the Smartphone industry with the iPhone that was introduced in 2007 which is its best selling product, it produced the iPod-iTunes duo in the early 2000s which revolutionized the music industry and its Apple stores which it started opening and operating in 2001 have $5,500 sales per square foot twice the $2,900 per sq. foot generated by Tiffany's stores.
Dell as I see it is trying to reinvent itself from consumer PCs into enterprise services and solutions. Think IBM (NYSE: IBM) which introduced the PC in 1981 however sold its entire PC division to Lenovo in 2005 and is now entirely focused on enterprise computing.
Figure 1: Dell's Revenue and Operating Income by Global Segments
As you can see from the above financial results Dell's largest revenue segment were large enterprises and while the consumer segment slightly shrank over the past 3 years, the large enterprise segment increased by about 30%.
Dell is also starting to heavily focus on software development. As the traditional software makers such as Google and Microsoft are moving into hardware and abandoning or at least becoming more independent from their OEM partners, the response of hardware makers such as Dell and HP was to move into software.
John Swainson, Dell Inc's new software chief plans to increase the size of the business five-fold from the current $1.2 Billion to $5 Billion. Dell has been on acquisition streak of software companies lately with the $2.4 Billion acquisition of Quest (NASDAQ: QSFT) being the latest addition.
I believe that Dell may be a good candidate for a LEAPS** call option. I think that the company has a good chance of performing a turnaround in the next few years and it's currently trading at a historical support level.
The $10 Jan 2014 call is currently trading at $3.10. This gives you a $2.2 margin of safety from the current price and a leverage of 4:1 meaning that you can control 4 times the number of shares with the same amount of money. Now if we assume that Dell reaches its 52 week high of $18 you would make $4.90 per share*** which gives you a gain of 158%**** on a 50% stock move which is very possible for a turnaround story. If you believe that Jan 2014 is too soon for changes in Dell's strategy to be reflected in its operating results you can wait for 2015 LEAPS options which are going to be rolled out in September, but you would have to pay more for the extra time premium.
Note that when using options you can lose your entire investment if the option expires and the stock is below the strike price. Meaning that if by the third Friday of Jan 2014 Dell's price is $9.90, the LEAPS option above would be worthless and you would lose your entire investment, but if you owned the stock you would only be down about 20%. Therefore you should be careful with position sizing when it comes to using options.
Bottom Line:
I think that Dell is pretty attractive at this price and if you believe that Dell can turn it's self around over the next few years, you can maximize your return though LEAPS options
Notes
* Wintel: Windows OS and Intel chips duo that are used in most PCs
** LEAPS: Long Term Equity Anticipation Securities, an option with an expiration date of more than 6 months
*** Calculation: (price- strike price) - premium paid
($18 - $10) -$3.10 = $4.9
**** $4.9/$3.10 * 100 = 158%
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