Round Two from Round Rock: 8,800 Layoffs at Dell

Earlier this week I wrote about the push by Dell (DELL) into the retail channel as a way to boost sales and gain traction against Hewlett Packard (HPQ). On Thursday the company beat estimates for their first fiscal quarter and announced the second prong of their turnaround plan; 8,800 layoffs (10 percent of the workforce). Although Dell has perfected the very efficient direct model, evidently the company has some fat it can trim, which should help offset any margin pressure from their plan to sell lower end desktop PCs in Wal-Mart (WMT) locations starting in mid June.

Assuming the consumer experience won’t be adversely affected by the job cuts, this appears to be a good decision, from a shareholder perspective at least (some employees obviously might feel otherwise). Dell stock jumped more than $1 in after-hours trading to over $28 per share. The stock isn’t cheap enough to peak my interest, but I wanted to take a quick look and see what kind of upside investors should expect if the turnaround proves successful. The moves the company is making have a good chance to give the company some upside to currently low expectations this year and into 2008. But how much is the stock worth?

The reason I say Dell shares aren’t that cheap is based in part to where companies like HP and IBM (IBM) are trading (15x and 14x 2008 estimates, respectively). What kind of P/E should Dell get based on those comps? I would say 15 to 16 or thereabouts, but the good ol’ days of a 25 or 30 P/E for Dell seem to be over.

As far as earnings go, I decided to be pretty aggressive on this assumption, giving the company the benefit of the doubt regarding its new restructuring plan. Current forecasts call for about 2% revenue growth this year, followed by 6% in 2008. Changes at the company likely won’t produce results overnight, so a re-acceleration in sales is likely to be more pronounced in 2008. Let’s assume they can grow sales 10% next year, to more than $64 billion.

Furthermore, let’s assume that Michael Dell can get the company back to peak operating and net income margins. Profits peaked at 6.4% of sales in 2005 before dropping to below 5% last year. Assuming 6.4% margins on $64.3 billion in sales for 2008, the company gets to earnings of $1.83 in 2008, well above current estimates of $1.49 per share. Assign a 16 P/E and the stock price would be above $29 per share. Even if we stretch the P/E to 18 (Dell used to trade at a premium when they were tops in the industry, so this is plausible if they regain their former glory) there is upside to $33 per share, about 16% above the current quote of $28 and change.

The bottom line: Dell stock could definitely keep rising if their turnaround efforts pay off in coming quarters, but make no mistake, this isn’t going to look like the 1990’s by any means.

Full Disclosure: No positions in any of the companies mentioned at the time of writing

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4 Thoughts on “Round Two from Round Rock: 8,800 Layoffs at Dell

  1. David on June 1, 2007 at 6:03 AM said:

    Quick comment on your PE computations. You’re forgetting the well-over-$5 in cash per share on the balance sheet. Add that to your valuations and you should probably see a stock in the 32-38 range. Pretty good, b/c that’s exactly where Bill Miller said he sees the fair value of Dell. Nice work on the valuation!

  2. Chad Brand on June 1, 2007 at 6:23 AM said:

    Hi David,

    Thanks for pointing that out. Dell’s cash is generating a lot of interest income which is contributing to the company’s earnings to the tune of more than $300M per year, or about $0.15 per share. So while $5 in cash per share does not add $5 in value, you are right it would boost the valuation target, assuming they don’t use any of that cash for buybacks in order to hit the earnings numbers.

  3. David on June 1, 2007 at 12:50 PM said:

    I respectfully disagree with you about the $5 not adding $5 in value. Maybe a bit less but certainly not a multiple on the interest generated. Dell will use the cash for share buybacks once the SEC investigation is over, which, even if the stock is fairly valued, will boost EPS and the subsequent stock price, all other things being equal. In general, when thinking Buffet-like, i.e. “what is the company worth to a potential buyer,” counting the cash as full cash is the right thing to do.

  4. Chad Brand on June 1, 2007 at 1:17 PM said:


    Why would a buyer pay a multiple on interest income plus the full amount of the cash hoard that is producing that income? If I have a savings account with $100 in it today, would you pay me more than $100 for that account because it was paying interest? If so, why?

    As to the buyback issue, you have to account for the fact that the buyback is offsetting some options grants as well. So, $1 in buybacks will add less than $1 of value to Dell’s earnings.

    I agree that they will buyback more than they issue, so share count will continue to drop as it has in previous years, thereby creating value. But again, it’s not going to be a 1-for-1 ratio unless Dell halts all options grants.

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