Dell Shares Look Excessively Cheap

It has been a long time since I can recall seeing a blue chip company like Dell (DELL) carry such a meager stock market valuation. It is true that Hewlett Packard (HPQ) has been stealing market share from Dell in recent years, and even overtook them as the world’s leading computer maker, but investors seem to be pricing Dell stock as if they are no longer relevant in the computer hardware marketplace. Given that Dell remains number two worldwide in PC shipments, I think pronouncements of their death may be greatly exaggerated.

Just how cheap are Dell shares? Well, Dell currently has about $8.8 billion of net cash on their balance sheet, which equates to nearly half of their share price ($4.50 per share in net cash versus a stock price of $10 and change). Total cash of $5.50 per share (excluding debt) is more than 50% of their current share price. I can’t name another profitable blue chip company that trades at just two times net cash.

Given the low stock price, Dell’s operations must be going horribly wrong, right? Well, not really. For their latest fiscal year, which ended January 31st, Dell earned an operating profit of $3.2 billion. Subtract out income taxes and Dell’s operating businesses are earning about $2.4 billion per year. This compares very favorably to their enterprise value of around $11 billion. At $10 per share, Dell stock trades at less than 5 times operating earnings. Is it a stretch to think it could fetch twice that price sometime down the road? Not in my view.

Now, something could certainly get in the way of this analysis. Excess cash is a great thing to have, but it can easily be wasted by management. Dell has been doing many smaller acquisitions in recent years to beef up its product line. If management did a large deal (using their cash war chest) and it turned out be a bad idea, shareholder value could be destroyed rather quickly.

Another risk is that they use their excess cash to beef up research and development. I say this could be a negative because the new products might not pay off. For instance, there have been rumors for months that Dell is developing a cell phone line. As a shareholder, I don’t care for this idea. The cell phone market is crowded and Dell has no experience in it. If they spend hundreds of millions on something like that, and it fails, a once large cash hoard could quickly shrink without much to show for it.

Regardless, Dell stock looks very cheap to me, especially if management spends their money wisely in coming years. Finding such strong companies at discounted prices isn’t always easy, but in this case Dell looks to be a bargain. Feel free to let me know what you think.

Full Disclosure: Peridot Capital was long shares of Dell at the time of writing, but positions may change at any time.

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18 Thoughts on “Dell Shares Look Excessively Cheap

  1. I think you make, what I believe to be the same mistake most people make when looking at Dell’s enterprise value. Due to the company’s well discussed negative working capital, I believe you have to look at the the excess of current liabilities over current assets as debt of the firm. That is, if you are going to consider their EV as MC + Debt – Excess Cash, you have also have to consider that they would have to settle those current liabilities. While I don’t think this changes the investment case, it does impact the valuation ratios. Thoughts?

  2. Chad Brand on April 13, 2009 at 5:20 PM said:

    Accordingly to their latest financial statements, Dell’s working capital was a positive $5.3 billion.

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  4. Fair points indeed Chad. I’m wondering what you think is Dell’s biggest headwind going forward then?

    Sure, it’s definitely cheap and has a massive amount of cash per share. But, things can also remain cheap for a long time unless they make something happen. I think after using the cash as a cushion to stave off this recession they’ll have to do something with it. Walk with me through a theoretical scenario where they would purchase someone… who do they buy?! I’m having a hard time figuring out what would really integrate into their business given their directional uncertainty (my opinion/perception). If they try to diversify more ala HPQ, it’s almost a losing battle because HPQ has been dominant.

    Fully agree with you re: value. But, I’m looking at the macro environment and looking at what they can do with the cash for catalysts to evolve & grow the business and I’m left scratching my head. More research/innovation? (Smartphone?) Different growth strategies/target markets? Hmm. Maybe I’m just not understanding the story.


  5. Hi Chad,
    I agree that Dell looks cheap. But what good is a lot of cash if there is no vision regarding how to use it for future growth opportunities. What is continuing to depress their stock is that there is a definite lack of visionary leadership regarding future growth. I have been listening to Michael Dell on their earnings conference calls and he is very uninspiring in terms of (a)specific financial goals/targets; and (b)a vision for future growth. This is very disturbing. They are continuing to lose ground against HPQ, Apple, Lenovo, and Acer (all strong competitors) and in an industry that is becoming ever-more commoditized (some volume growth but at ever lower unit prices). Bottom line — management needs to convince us they have a vision and strategy for growth that is plausible — until then, better opportunities elsewhere.

  6. Chad Brand on April 14, 2009 at 8:56 AM said:

    Right now Dell is focused on stabilizing market share and cutting costs dramatically. In recent years their corporate overhead has really ballooned. They could really see some nice margin expansion if those efforts pay off.

    In terms of acquisitions, I really don’t want to see them do a large deal. I just think they are best served maximizing the efficiencies of their current business rather than expanding into others right now.

    In the past Dell has used a lot of cash for share buybacks and I think that is a better use of cash than trying to be a player in the cell phone market, or any other area they are unfamiliar with. Cutting costs and reducing share count could boost earnings up to the $1.50 range when the economy stabilizes, which alone could get the stock to the high teens. After their business is running smoothly maybe then they should focus on growth again.

  7. You’re double counting the cash to get to a positive WC. You’re taking it out in calculating the EV, and then once again counting it in coming up with a positive WC. Since you already took it out in saying that 50% of the company’s value is Cash, you have to recognize the excess of CL over the REST of CA.

  8. Chad Brand on April 14, 2009 at 9:13 AM said:

    Working capital is defined as current assets less current liabilities, which is how I am calculating it.

    I chose to value DELL using an “enterprise value/EBITDA” ratio in my post (working capital doesn’t factor into that valuation metric).

  9. Chad,
    You say “Dell is focused on stabilizing market share”. That’s certainly a worthy objective, however they are clearly failing in that regard. Consider Credit Suisse comment out this morning:
    “Dell’s margin preservation strategy is costing more market share. Dell’s focus on gross margin preservation led to unit
    declines of 16.9%, far worse than the industry. This was, however, better than our estimate for a 19.9% unit decline in the
    April quarter. Again, ASP weakness may counter the potential upside here. Acer is now almost tied for the #2 market share
    position with Dell.”

  10. Chad Brand on April 16, 2009 at 8:50 AM said:

    I agree. One of the readers brought up a vision for future growth and my point was to say they are focused on just keeping the customers they have, so growth really isn’t something that is of great concern right now. They are moving more into retail to stabilize share, but you are right, the moves have not shown results yet. I do think the brand is in a position to survive and thrive, they just have to execute better. I think the move into retail recently, though, shows they are not solely focused on margins. Whether the move pays off remains to be seen.

  11. Dan (The Curious Investor) on April 16, 2009 at 2:43 PM said:

    Just to jump in on the net working capital point, I think the point that BP is trying to make here is that, in the event that Dell’s revenues continue to fall, working capital needs will consume some of the cash on the balance sheet.

    The net working capital number that you (Chad) calculate using the explicit “current assets – current liabilities” formula is more of a “unrestricted cash” number. That is, the amount of cash management has in excess of its need to fulfill current liabilities in the event of some sort of immediate stress. This is the cash that can “safely” be used for non-core business “value creation” type transactions – buyback shares, make capital investments, make acquisitions, etc. Thus, as a very conservative value investor concerned with his margin of safety, you would probably say that share price is supported by $2.60 per share in unrestricted cash versus the $4.50. That being said, a share price supported by 25% distributable cash is still Apple-esque in sofar as untapped value in the balance sheet.

  12. Chad Brand on April 16, 2009 at 2:51 PM said:

    I certainly don’t refute the fact that Dell needs a certain amount of cash onhand to run its business, so all of it is not available for buybacks, etc. Still, that is the case with most any company so I don’t think it renders the enterprise value metric less important for Dell than any of their competitors, which is how the stock will be analyzed.

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  18. Yes dell from an expensive brand has becoming cost effective way to promote the sales.. which i think has worked..

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