Dell in Barron's

Barron’s published a negative story on Dell this weekend. (“It’s too Early to Hit Restart on Dell Shares”, Pg 28, April 21, 2008). The article did a reverse Oprah – instead of the negative stuff up front, with a positive reconciliation at the end to make everyone feel better - the Barron’s article started off positive (US personal computer market share increased in Q1 to 30.9% from 27.7%, while HP slipped slightly to 24.3%), and then listed the negative points. The most cogent points of the article: Dell is still losing money in the consumer business, as 94% of the PC-industry growth now comes from abroad where HP dominates. The article did some positive-negative contrast – but the tone was negative. One unnamed hedge fund manager is quoted as suggesting that Dell’s earnings multiple should be closer to 8x, rather than the 13.5x-14.x of HP and IBM, respectively, implying that Dell shares are more appropriately valued at less than $14, about 25% lower then current levels.

According to the story, David Bailey at Goldman Sachs reduced his rating on the shares to Neutral subsequent to the analyst’s meeting on April 2-3, owing to the large number of moving parts required to work properly together in order to make the turnaround successful. Those moving parts are: 1) changing its low-cost direct-sales model to one requiring multiple-product platforms, so it can sell items like notebook computers in multiple channels such as retail stores, 2) attempting to upgrade consumer service, 3) the retail store initiative, and 3) push into lower margin emerging markets and building a tech consulting business to rival IBM and HP.

None of this is new and Barron’s should have published this story two weeks ago after all the stories appeared after the analyst’s meeting.

Nevertheless, two points were made, but were not elaborated upon. First, the article quoted Ron Garrigues suggesting that it could take another year before his unprofitable consumer products division returns to profitability. Secondly, the article makes a passing mention that there has not been any evidence of execution over the last two years (that comment was made by Sanford Bernstein analyst Tony Sacconaghi).

In addition, the big wild card – which few people seem to understand – hence, its position at the end of the article, almost like a throwaway – is the fate of Dell Financial Services (DFS). It is likely that Dell will sell DFS following Don Carty’s “strategic review”, meaning that a large write-off is pending on the ultimate sale price of the entity as well a write-off on a portion of the securitized assets on its books.

Let’s be clear. The real issue at Dell going forward is execution risk. There will be no near-term turnaround in Dell Inc. The shares are “dead money”, but will follow the general market as the largest number of institutional stock holders are index funds. Hence, any upward price drift may be misinterpreted as execution progress.

The new executive management team has been in their current roles since early 2007. In other words, they have had time to review their respective operations, develop a plan for the future, and begin the restructuring process. Headcount reductions continue, and employee morale continues to find new lows. Hence, we believe that any substantive evidence of progress on the turnaround is still several quarters away. However, Dell’s executive management team is talking about the “opportunities” in front of them. That means that several quarters away times two.

So what’s the bottom line? Last week, IBM showed that its software strategy – which has been 8 years in the making – has begun to pay off – in spades. Dell’s software “strategy” at the enterprise level, is just beginning. It's primary competitors have articulated a similar software strategy. Why would anyone think that this executive management team will be able to execute on their restructuring and growth strategy in half the time, let alone one-quarter of the time that it took IBM? Is this team confident in its ability to execute on its restructuring strategy? A little humbleness and humility would have been refreshing. Instead, we saw that this team is arrogant. As a result, we believe that the biggest hurdle at Dell Inc. is that Michael’s new leadership team is completely out of touch with the market, and they are isolating him from truly seeing and understanding what is going on.