How Long Do Investors Have To Wait?
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It seems I’ve been pounding the pavement all year waiting for Dell (NASDAQ: DELL) to realize the underlying value in its business. I say this with full understanding that PC’s are no longer going to be a crucial part it. However, Dell has been spending left and right trying to migrate into more of a services business – one that rivals IBM (NYSE: IBM). Although it’s a good strategy, there have been no meaningful signs of progress. And it seems that the Street is beginning to lose patience.
Unwanted By S&P, Heartbroken By Investors
It’s bad enough that the rise of tablets and mobile devices from the likes of Apple (NASDAQ: AAPL) has all but killed a once booming PC industry. Also, with Microsoft (NASDAQ: MSFT) opting to build its own Surface tablet, Dell was essentially told by an OEM partner that it can no longer be trusted to build a platform that won’t make Windows 8 look bad.
Unfortunately for Dell, early sales reports suggest that Microsoft’s Windows 8 has yielded very little in terms of PC sales, which have actually dropped almost 9%. In other words, both sales of Surface and Windows 8 have been abysmal and should no longer be considered a catalyst for PC growth.
Meanwhile, sales of Apple devices continue to rise with Apple having reached 53% market share according to a report released on Friday by Kantar Worldpanel ComTech, which tracks sales data for the 12 weeks ended Nov. 25. Essentially, while PCs are (in fact) dying, mobile devices have yet to peak. This means that Dell still has yet to realize that it is in the wrong business.
Now adding insult to injury, on Friday, Dell then learned that it was being booted out of the S&P 100 index. Upon the announcement, representative from the index said this: “Dell has a market capitalization below $18.5 billion and is no longer representative of the mega-cap market space.”
It’s hard to imagine if there can be a bigger indictment of the PC industry if not this. I’ve always liked Dell. However, I’ve constantly questioned the company’s ability to grow its high-margin segments such as networking and servers. The company has not put sufficient resources in areas where there is real growth potential. Today, it’s paying the price.
However, these days it would seem that “paying” is what Dell does best. The problem is, the company has not realized the returns on these investments. For instance: the company spent $2.4 billion for Quest Software, a deal which arrived shortly after it bought security company, SonicWall for an estimated $1.2 billion.
These acquisitions followed purchases of Wyse Technology, Perot Systems and then KACE Networks, which Dell scooped up in 2010. Understandably, Dell sees that its business is eroding, so the company feels the need to offset its weakening PC hardware business by strengthening areas in software.
Unfortunately, the market has grown impatient and Dell’s Q3 earnings report didn’t do much to change anyone’s mind. Granted, with Apple’s dominance in the market, I don’t think the Street expected Dell to blow the doors off in the report. On the other hand, the numbers arrived much worse than even the most bearish assumptions.
The Disaster that Was Q3
Dell reported an 11% year-over-year decline in revenue, which also arrived 5% worse sequentially. Declines appeared in every segment led (obviously) by a poor PC performance which posted an 18% drop year-over-year. The company’s laptop segment dropped 26% while software and peripherals shed 11%.
As I’ve said above, one of Dell’s biggest failures continues to be that it discounts its own growth areas such as networking and servers. During the quarter, these were the lone bright spots of the company – growing 11% year-over-year and 5% sequentially.
Margins continue to present struggles. The company posted a one point drop in non-GAAP gross margin, which also shed 60 basis points sequentially. Operating income also fell by 1/3 year-over-year and declined sequentially by over 20%. Sadly, Dell has had no answers as to how it is going to stop this bleeding. For investors, the decision is easy - the stock is dead money.
For these reasons, I continue to see Dell’s future being less reliant on these losing end-markets to something more of a cloud-based service company – a transition that IBM was able to make perfectly. Likewise, that IBM was able to close its acquisition for Kenexa, this only fuels the similarities between the two companies – particularly for Dell’s recent service acquisitions.
The Kenexa deal now makes IBM (arguably) the leader in enterprise social software and the company’s solutions already cater to approximately 60% of the fortune 100 companies. What exactly is Dell waiting for? PCs are dying and it will never catch Apple. IBM realized this over a decade ago. Dell needs to make this connection.
At this point, Dell is not going to ever beat Apple, Google and Samsung in the new age of mobile. The company’s only chance of survival rests on its ability to shift into a services-oriented company. IBM proved that it can be done. But on the other hand, the transition took much longer than anyone had hoped. The market does not appear willing to wait - it’s hard to blame them. Dell’s “stepping up” time is long overdue.
rsaintvilus is long AAPL and has no positions in the other stocks mentioned above. The Motley Fool owns shares of Apple, International Business Machines, and Microsoft. Motley Fool newsletter services recommend Apple, International Business Machines, and Microsoft. 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!