A $25 Billion Price Tag is Low for Dell

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Dell’s (NASDAQ: DELL) shareholders must've been happy when the stock price increased from $10 per share to $13 per share, a 30% return in a month. In addition, its founder and CEO, Michael Dell, and Silver Lake Partners have been talking about a leveraged buyout for around $25 billion, or $14 per share. Is $14 a reasonable price for Dell? Let’s see.

Decent 10-Year Operating Performance

Dell seems to be quite vulnerable to the overall declining PC sales environment. It has three main business segments: Large Enterprise, Public, Small and Medium Business, and Consumer. In 2011, the majority of revenue was generated from Mobility Client products; $19.1 billion, accounting for 31% of the total revenue. Desktop PC's ranked second, with $14.1 billion in revenue, accounting for 23% of the total revenue. Software and peripherals represented around 17% of the total sales. In the past 10 years, Dell has generated consistently positive net income and cash flow. The 10-year average net income was nearly $2.7 billion, whereas the 10-year average operating cash flow and free cash flow were $4 billion and $3.5 billion, respectively.

Notably, in the past 10 years, Dell has managed to deliver a consistent double-digit return on invested capital.

<table> <tbody> <tr> <td> <p>%</p> </td> <td> <p><strong>2002</strong></p> </td> <td> <p><strong>2003</strong></p> </td> <td> <p><strong>2004</strong></p> </td> <td> <p><strong>2005</strong></p> </td> <td> <p><strong>2006</strong></p> </td> <td> <p><strong>2007</strong></p> </td> <td> <p><strong>2008</strong></p> </td> <td> <p><strong>2009</strong></p> </td> <td> <p><strong>2010</strong></p> </td> <td> <p><strong>2011</strong></p> </td> </tr> <tr> <td> <p><strong>Net margin</strong></p> </td> <td> <p>5.99</p> </td> <td> <p>6.38</p> </td> <td> <p>6.18</p> </td> <td> <p>6.39</p> </td> <td> <p>4.5</p> </td> <td> <p>4.82</p> </td> <td> <p>4.06</p> </td> <td> <p>2.71</p> </td> <td> <p>4.29</p> </td> <td> <p>5.63</p> </td> </tr> <tr> <td> <p><strong>ROIC</strong></p> </td> <td> <p>39.84</p> </td> <td> <p>43.33</p> </td> <td> <p>44.18</p> </td> <td> <p>61.46</p> </td> <td> <p>51.45</p> </td> <td> <p>61.92</p> </td> <td> <p>45.43</p> </td> <td> <p>16.49</p> </td> <td> <p>21.11</p> </td> <td> <p>20.43</p> </td> </tr> </tbody> </table>

The net margin has been fluctuating. In 2009, its net margin was only 2.71%. However, the margin has already improved in the last two years, with 4.29% in 2010 and 5.63% in 2011. Trailing twelve months, the net margin was 4.44% and the ROIC was 13.11%.  The operating cash flow and free cash flow came in at $3.68 billion and $3.13 billion, respectively. 

A Buyout at Low Valuation

As of October 2012, Dell had $10.1 billion in total stockholders’ equity, $9 billion in both long and short-term debt, and $14.2 billion in cash, most of which was held overseas. So Dell had net cash of around $5 billion. Taking the cash out of the offer amount, the real price would be $20 billion. A $20 billion price tag would value Dell at around 7.4x average 10-year earnings and 5.7x average 10-year free cash flow. Dell was estimated to earn around $1.70 per share in 2012 and around $1.66 per share in 2013. Thus, the deal valued Dell at nearly 6.8x forward earnings, after subtracting the net cash position. Andrew Barry of The Wall Street Journal argued that LBOs were normally done at around 15x after-tax earnings. In terms of EV multiples, the deal valued Dell at 5.63x trailing EV/EBITDA. It was a record low valuation in the past 10 years. In a study done by Akerman, the lowest EV/EBITDA was 5.9x in 2002, and the highest EV multiple was 9.5x in 2008. The 10-year average EV multiple stayed around 7.88x. Thus, a deal offer is actually quite low.

<img src="/media/images/user_14219/screen-shot-2013-01-25-at-80547-pm_large.png" />

Peers Comparison

Among the PC makers, including Dell, Hewlett-Packard (NYSE: HPQ), and Lenovo Group (NASDAQOTH: LNVGY), HP has the lowest valuation. At the current trading price of $17 per share, HP is valued at only 3.43x EV/EBITDA. However, HP has recently had to take an $8.8 billion impairment charges from its big acquisition of Autonomy due to its accounting fraud. Lenovo is the most expensive, with 8.26x EV/EBITDA. Among the three, Lenovo seems to be the most active company to prepare for the industry shift from PC to smartphones and tablets. At the 2013 International Consumer Electronics Show, Lenovo introduced its latest products, including a 27-inch PC touch tablet, IdeaCentre Hozion, and a 39-inch Table PC.

Foolish Bottom Line

Personally, I do not think the $25 billion price tag was fair to shareholders. If simply placing the average 10-year EV multiples on Dell’s trailing EBITDA, Dell should be worth around $34.6 billion, 38% higher than the current offer.

hoangquocanh has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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