process-improvement-solutions.com Blog

Dell is a great example of good Working Capital Management. They usually have a negative WC. For details on this click here (2MB PDF file) ->

http://process-improvement-solutions.com/Working_Capital_Gap.pdf

Dell seems to be transforming itself by acquiring the skill sets needed to provide complete solutions to customers instead of just a system thereby repositioning itself during a trough in the economy. Some of the skill sets are being acquired by hiring talent from competitors and some via acquisitions like the Perot Systems deal with the objective being to transform itself from being a vendor of just products to provider of services..

Dell had already reorganized into corporate (Small/Medium and Large), Consumer and Public Sector divisions which is a technique borrowed from GE that enables the corporation to better service its market segments by allowing all internal processes to be reorganized in terms of value provided to the customer. With today’s completion of tender offer for Perot Systems, Dell created a new business unit for Global Services similar to IBM’s Global Services division.

With $12 Billion dollars in cash on the balance sheet ($9 billion net of debt), Dell stock is trading at just under 5 times it’s trailing EBITDA (net of cash). Earlier this year when it was under $8 dollars, Dell was trading at just little above the cash on its balance sheet. Interestingly enough, this was the exact same situation Apple was in 2001/2002 when it bottomed out at just around $8 (at just under $8 billion market cap) with about that much in cash at that time.

Going forward, this repositioning strategy should enable Dell to expand its Operating Margin for itself and provide better value to its customers – consumers, government and business. In fact Dell is now the Amazon.com for corporations looking to one stop shop for their Information Technology needs including perhaps business process consulting and re-engineering eventually.

Update 1 (Nov 6, 2009)
So Dell’s approach to repositioning is different from Apple’s in 2002 (consumer products was Apple’s focus). It is a combination of Apple, IBM and Amazon strategy in the sense that Dell seems to be more interested in premium products for the consumers, services for corporations and public sector and one stop solutions provider for commercial and public sector. In essence, Dell is thinking a lot bigger than trying to do a Steve Job’s act.

Intel Rebates Issue
Rebates from suppliers to their biggest and best customers is a fairly common practice in all industries. For example, engine manufacturers routinely provide rebates to their truck customers. Most industrial’s do this. The reason this specific case is being singled out is because of Intel’s dominance in the processor space. Intel made a strategic decision to focus on Micro Processors over DRAMs under Andy Grove and since then has been able to constantly innovate and keep all competition at bay. Innovation and then fabrication in this space is very capital intensive. It is very hard for competitors like AMD to catch up once Intel has had such a huge lead. That by very definition is the true nature of free market system – the winners usually take all with distant 2nd and some times 3rd players (Duopoly) when the leader has a significant competitive advantage – it is happening in the financial sector right now after all the turmoil. Apple was able to establish huge dominant position with IPOD by locking up the supply chain for couple of years (in addition to creating the iTunes eco-system). This should be a non issue for Dell. As they said, they are free to choose their suppliers and in fact seemed to have managed to introduce AMD chips as well.

Update 2 (November 14, 2009)

Intel Rebates issues as I said above, is a non issue. Intel appears to have made a truce with AMD and the antitrust lawsuit should eventually loose its teeth in Europe and US. For Dell, over those five years it’s revenue was over $250 Billion. The $5 Billion seems to have been accounted for via either COGS reduction (challenging endeavor to match it with revenue since the rebates might be asynchronous) or put in a other bucket in the income statement and balance sheet (I looked at the statements for the years in question). The other bucket is quite small (few million).

Dell’s Smart (Phone) China Move

This is a smart (phone) move by Dell – Open source as opposed to proprietary software and entry via geographic location where the opportunity is vast and competitors are limited (as of now). The US dominance in smart phone segment by Apple and RIM is unlikely to continue.

In international markets like China, the smart usage is much different than in the US or Europe. Most consumers in countries like China, Brazil and India (BRIC countries) don’t even have landlines or access to internet at home or work (the problem in India though is that there are very strong local telecom competitors and regulation). Russia is still the wild west and very risky. Most of the consumers there depend on these phones for all their communication and online needs. They need real utility features and not millions of non value added apps that serve no real purpose except for bragging rights in commercials.

An excellent example is Vodafone’s Japanese foray. Vodafone entered Japan with same strategy that proved to be successful in Europe and failed miserably. The reason being that the Japanese consumers’ smart phone usage is quite different from the Europeans.

With focus and entry via China, Dell’s probability of success is greater in this space compared to foray via the US market by taking on RIM and Apple head on. Making it open source using Google’s Android makes lot of sense since in essence this allows the local market to develop the product and its applications. Dell can then learn from that and adopt the successful aspects for other markets.

The likelihood of a corporation being able to replicate iPod/iPhone/iTunes or Blackberry like success is very small – showing the consumers the hidden need and getting them to adopt it (with help from an excellent supply chain/content strategy by Apple and a great e-mail application by RIM). Nokia seems to be trying to replicate Apple by focusing on creating a content eco-system. Dell’s strategy (based on information available so far) appears to be to allow the marketplace and consumers evolve the eco-system – especially in a market the needs of which are unknown and the infrastructure limited.

Update 3 (November 21, 2009)

I am disappointed with Dell’s inability to manage the short term while executing the long term turnaround strategy. Having said that, by the nature of its current business model, Dell might be limited in what it can do to manage the short term results. I am still holding on to my Dell. Down side is limited. It is again trading it less than 5 times trailing EBITDA net of cash ($14 Billion Cash, $3Billion Debt, $11Billion net cash on Balance Sheet, $28Billion Market Cap, market value after cash is $17Billion, Trailing EBITDA is $3.73, 17/3.73 = 4.55). Even if the market were to correct, I don’t believe Dell will go down much from here.

The turnaround strategy is being executed, hence those restructuring charges. The gross margin was inline with historical average for this decade. This miss on the revenue was quite small (12.9B vs $13.2: 2.2%) and was higher than some analysts estimates. The real metric to watch is Operating Margin – that is what will create value for the shareholders as this turnaround strategy starts bearing fruit next year.

I also belive now that Dell is a possible take over candidate because of its valuation. The margin extraction from that $60 Billion in revenue would be easy with vertical integration play.

February 22, 2010 Update

The Perot acquisition is starting to payoff at the top line (30% Sequential growth in services). However, the cost of services revenue went up by 38%. There is room for improvement in services cost of revenue.

On the Operating Margin front, there was a $202 million charge related to restructuring and acquisition in addition to amortization charge of $86 million (about half of which looks like was because of Perot). So approximately $250 million hit to operating margin was due to restructuring and Perot Acquisition which translates to about 12cents/share.

Again, Gross Margin was within the normal range for the past decade. As stated above, the real metric to watch is Operating Margin which can be managed in spite of Gross Margin Contraction as demonstrated by numerous well run companies operating in highly completive environments.

Going forward, as the top line improves and acquisition/restructuring charges disappear, the Operating Margins should improve exponentially.

September 27, 2011

HPs missteps should also benefit Dell. PC market share, mobile, Enterprise, Services etc.