For You Believers in DELL

[Parsad]

I started this thread based on some comments by Txlaw on the Microsoft thread.  Feel free to chime in. 

 

In regards to DELL, I see how cheap the stock is on an enterprise level, especially based on the amount of cash in the company above and beyond what would be required for payables.  But what competitive advantages do you see with DELL?  I'm one of those guys that believes owning the software platform has more of a competitive advantage than the hardware side. 

 

Cheers!

[Packer16]

I think you have to look at IBM as the model of a huge tech company with moats who via buybacks and execution has provided 12% per share FCF growth over the past 5 years.  The buybacks have been on the order of 4% per year so there organic FCF growth has been about 8%.  Another aspects of moats is FCF return on working capital and fixed assets. For IBM this number is about 71%.  For this level of perfromance, IBM trades at 13x FCF.

 

If you compare this to MSFT you get per share FCF growth of about 9% with about 4% repurchases so you have about 5% organic growth.  MSFT's FCF return on working capital plus fixed assets is 276% (as MSFT has about $47 billion of excess cash). MSFT trades at about 6.5x FCF.

 

As for DELL, average FCF has declined over the past 5 years (as with many tech cos) as well as there margins.  The moat clearly is not as good as MSFTs or IBMs.  DELL's FCF return on wokring capital plus fixed assets is 184% (as DELL has about $11 billion of excess cash). This is reflected in a share price of 6x FCF.

 

As for CSCO, average FCF has increased over the past 5 years about 13% with about 2% repurchases so you have about 11% organic growth.  CSCO's FCF return on wokring capital plus fixed assets is 227% (as CSCO has about $38 billion of excess cash). CSCO trades at about 6.0x FCF.

 

From these metrics, it appears that MSFT and CSCO are better buys than DELL but all of these stocks are cheap based upon the Graham growth formula which would imply P/FCFs in the low 30s for IBM and CSCO and P/FCF of the mid 20s for MSFT.

 

Packer

 

 

[Parsad]

From these metrics, it appears that MSFT and CSCO are better buys than DELL but all of these stocks are cheap based upon the Graham growth formula which would imply P/FCFs in the low 30s for IBM and CSCO and P/FCF of the mid 20s for MSFT.

 

Yes Packer, I agree.  As long as they are around in ten years!  ;D  Cheers!

[Packer16]

I think IBM's example provides a good road map.  IBM has been around since the 1920s and has always been able to re-invent itself when required.  As a matter of fact, Graham mentions them as 1 of 18 industrial companies whose bonds were tested in the Depression and passed (see page 81 of 1934 edition of Security Analysis).  In addition, it generated 10 -20% returns on equity during 1930 - 1933 period. 

 

Packer

[rranjan]

 

As long as they are around in ten years!   ;D  Cheers!

 

;D ;D ;D

 

Packer - IBM might have done it but I will not feel so comfortable about all companies capacity to do so.

 

Coming back to original question. Dell is trying to get into higher margin business.

Dell wants to change from a selling commodity boxes into becoming a trusted enterprise solutions provider, same as with Hewlett-Packard or IBM. They want to push into data center technologies including servers and storage, which has greater switching costs and also provide consulting services.

 

Problem is more than two thirds of Dell's revenue remains tied to commodity hardware (desktops, laptops, peripherals). Storage represents only 4% of revenue. They want to move so badly into services that they paid high price for Perot systems. They might not be able to replicate IBM because Dell lacks the relationships and high-end hardware offerings of IBM that often helps IBM to get many services agreement.

 

I don't think dell has any moat. While I prefer software related moat if everything else is same but even a hardware company can have moat. For example, I think INTEL has a decent moat if not great one but I think DELL does not have any moat.

 

I will love if someone can make me see the moat in DELL because it is cheap right now.

[Packer16]

I agree that HPQ is cheaper than DELL and probably better also but less so when compared to CSCO or MSFT.  My FCF numbers do include interest expense so the effect debt is removed from them.  For both CSCO and MSFT the required WC capital is close to zero once cash is set eqult to 5% of sales and the debt is removed from the current liabilities.  These companies are making incredible returns on assets and the market does not believe they will continue.  I think they will continue and margin of safety comes in that they would have to fall apart to meet the market expectations.

 

Packer

[Munger]

While no one knows exactly what Dell will look like in 10 years, the risk/reward at these valuation levels is extremely compelling.  No predictions on where the stock price goes but downside is limited given the cash flow characteristics of the business and the fortress balance sheet, which is comforting given the risk of a major downturn in the economy.  The upside is potentially significant.  I am long the stock (and have been since $12) because of the risk/reward not because I have any great insight into what the company will be in 10 years.

 

For a company with a supposedly weak competitive position, Dell has generated huge free cash flow and high ROIC every year except 1 since being a public company.  Few companies have generated such consistent and robust returns during this 20+ year period, which included a collapse of the tech bubble as well as the greatest financial crisis since the Great Depression and the rise of Apple.  A key competitive advantage for Dell is the scale of its distribution network.  And Dell has unquestionably strong corporate relationships on a global basis.

 

Don't underestimate Michael Dell.  This consistent performance reflects his business acumen and understanding/appreciation of free cash flow and ROIC.  Michael Dell has also reached into his back pocket and pulled out $200+ million of his own money to buy stock in Dell over the past 18 months.  In addition, the company has been aggressively buying back stock at current valuation levels.  Management is on our side and has every incentive to protect and create shareholder value.  I also see Michael Dell as one of the top tech executives on the planet -- he has been immersed in the industry since he was 18 years old...I'll take him on my side any day, especially against the hapless leaders at HPQ (a company that appears to be run by the board of directors).  HPQ is a company in complete and total disarray.

 

The PC is far from dead.  Enterprise service and solutions now represents 30% of the top line.  The company is managed to be a cash flow machine and generate high ROIC.  Find me another company that dedicates a portion of every quarterly conference call and investor presentation discussing their efforts to continually improve asset turnover -- these guys "get it"...

 

I believe Dell is one of the largest positions for Southeastern/Longleaf, who own about 8% of the company and coincidently hold 8%+ (including options) of their Partners fund in Dell.  They have openly shared their thesis on the company for those interested.

[goldfinger]

Dell's ability to serve mid to small businesses or specific teams within an organization is one big part of its moat. Many IT people directly go to Dell to order their next machines and do not think twice about it (servers, laptops, appliances etc...). They can adjust their needs through Dell's web site and order. Extremely practical, it almost has become a conditioned reflex to go see what they have to offer when new hardware is needed. As far as I know this model has not been fully replicated by others. Michael Dell has complemented this offering with additional services of higher value and margins and I think that actually reinforced this area. Himself said recently that competitors cannot serve mid to small businesses as well as they do. In many cases it is still true. They invested and are investing in cloud, storage, security, software and services. They can complement their offerings with the new kinds of devices, I do not see this area as disruptive and demands for PCs and servers will continue to grow. Margins are improving, the distribution chain has gone through a recent cycle of cost cutting and optimization, I do not think it is that easy to replicate their distribution channels.

So IMHO it is a combination of brand name - good low cost hardware, low cost on demand distribution channels, completeness of the offering and customization capabilities. This has not been replicated by anyone up to now.

[goldfinger]

Longleaf Partners Fund is what you might call the Navy SEALs of the financial world -- an elite group that shuns the spotlight while performing incredible feats where others fear to tread.

 

How Longleaf's manager, the employee-owned Southeastern Asset Management, can handle $40 billion with such success, while receiving so little recognition, remains a mystery to me. I think they must like it this way, and I have two theories why:

 

1. They want to emulate the underexposed, shareholder-focused managements of the companies they love to partner with.

 

2. By resisting the urge to chest-thump, they gain long-term investors, as opposed to speculators lured by past performance.

 

 

Longleaf stills own Dell stock, but it's added call options to its arsenal as well, essentially levering its position. Dell call options and stock now make up 7.7% of the Partners Fund.

 

Any Longleaf shareholder will tell you, being contrarian is what Longleaf does best. And at least in the past, it's made them a lot of money

 

Audio Longleaf's Staley Cates on DELL:

 

http://www.longleafpartners.com/media%20files/050510-07.mp3

 

 

________________________________________________________________

 

Notes From Longleaf Partners' Annual Meeting

 

http://www.fool.com/investing/mutual-funds/2011/05/18/notes-from-longleaf-partners-annual-meeting.aspx

 

Ben Graham I just listen to the mp3 and I could not agree more with them. Thank you, that was a pleasure to listen to their case.

[tombgrt]

Dell's ability to serve mid to small businesses or specific teams within an organization is one big part of its moat.

 

This.

 

+ You get the best owner management you can basically dream of, a business structure that enhances CF and +4$ in net cash. Cash which I trust will be better spent than the cash on CSCO's & MSFT's books.

 

Why are a lot of people so busy examining companies like RIMM if you can get this kind of company with a PE net of cash almost under 6? Bigger moat, a brighter (and more diversified) future and far better management.

 

 

@ Parsad : What do you think of INTC's moat as a company on the hardware side?

 

[Packer16]

From a business perspective, I put DELL's business alot closer to RIMM's than either MSFT or CSCO.  When you look at DELL's operating margins they have gone down from the 9% to the 7%s and FCF per share has declined by 12% over the past 5 years.  If this continues in the future, DELL is expensive.  I think M. Dell is smart manager but the businesses that he has to compete in are mediocre versus HPQ, MSFT, IBM or CSCO.  As a matter of fact if he was not such a good manager Dell may have gone the way Gateway.  HPQ's management my be in dis-array but it has a better collection of businesses to that genrate in the aggregate about 5% more in operting margin per year.  This is why you are seeing DELL pay-up for acquistions like Perot and the storage co they bought last year.  Dell may have a more skilled player but they we dealt one-pair while HPQ was dealt 3 of kind and CSCO and MSFT where dealt full houses.  I am not saying Dell is not cheap but you do have to ackowledge that their sets of business are of lessor quality than HPQ, CSCO, MSFT or IBM.  And with MSFT and CSCO selling at the same multiples as DELL, they appear to be cheaper.  As for Longleaf,  I agree they are smart guys but so far DELL and LVLT have been LT losers (aka "value traps") for them and have hurt performace significantly.  Does anyone know of Longleaf has ever said they made a mistake in a large purchase and subsequently sold?  I know Francis Chou said as much about a few large positions of his and I respect that in a manager very much.

 

Packer

[shalab]

Here is a question for DELL fans, Dell has gone away from its build to order model to the traditional model of build and then sell in emerging markets.  If you look at the payables in DELL balance sheet, you will see it declining every year.

 

 

[Munger]

When you look at DELL's operating margins they have gone down from the 9% to the 7%s and FCF per share has declined by 12% over the past 5 years.  If this continues in the future, DELL is expensive.

 

All businesses cycle -- none go up in a straight line.  Few businesses have demonstrated the multi decade durability and strength of Dell, which reflects in large part management focus on ROIC.  If focused on trends, recent results are of greater relevance and all metrics cited above have been improving in recent quarters.  In 1QFY12, margins improved much more than expected and operating income was up 67%, with FCF growth even greater.  The business mix is changing as Michael Dell has reiterated until he is blue in the face -- no one is listening.  

 

 

 

...but the businesses that he has to compete in are mediocre versus HPQ, MSFT, IBM or CSCO.  HPQ's management my be in dis-array but it has a better collection of businesses to that genrate in the aggregate about 5% more in operting margin per year. I am not saying Dell is not cheap but you do have to ackowledge that their sets of business are of lessor quality than HPQ, CSCO, MSFT or IBM.

 

Nothing personal but completely disagree.  Mistake to focus on margins in isolation.  ROIC is the relevant measure and while MSFT, IBM, and CSCO all generate excellent ROIC so does DELL.  I actually have started smaller positions in MSFT and CSCO.  Many of the HPQ businesses are actually in deep trouble...and now you have a CEO who is stepping away from those businesses in an effort to turn HPQ into a software company, essentially from scratch -- no prediction on HPQ but I'll grab the popcorn and watch as this drama unfolds...the board is a disaster -- decisions based more on business politics than business principles.  The acquisition of Palm will prove to be a complete disaster.

 

 

 

This is why you are seeing DELL pay-up for acquistions like Perot and the storage co they bought last year.  Dell may have a more skilled player but they we dealt one-pair while HPQ was dealt 3 of kind and CSCO and MSFT where dealt full houses.

 

"Pay-up" -- while tough to argue the acquisitions meet a Graham net/net criteria, I don't believe they have overpaid.  The acquisitions have been relatively small and business performance improves dramatically when plugged into Dell's distribution network.  And if I remember correctly, Dell backed away from a bidding war with HPQ -- Dell has shown a willingness to back away when the economics don't make sense no matter how much he may like the underlying technology, which is great for shareholders.  Most tech companies forget (or don't even have a clue) that the most relevant measure is FCF/share not the "sexiness" or "trendiness" of the technology.

 

 

 

 

 

 

 

[S2S]

This is why you are seeing DELL pay-up for acquistions like Perot and the storage co they bought last year.  Dell may have a more skilled player but they we dealt one-pair while HPQ was dealt 3 of kind and CSCO and MSFT where dealt full houses.

 

Dell might have "paid up" for Perot Systems, but Hewlett's own 3PAR acquisition mere months later made it look like a value buy.  ;D

 

 

My biggest concern with HPQ is that whenever I see how much effort the company put into building out its Service businesses and yet how much more ground it still needs to gain to effectively compete IBM and ORCL, I can't help but wonder when management will cave in and go after SAP.

[Packer16]

You are correct on the storage acquisition (HPQ did overpay and DELL backed away) but when you look at the relative sizes of the "good" DELL businesses (storage and services - 16%) versus the more commodity businesses, the rest, it may take awhile for the DELL to grow the good businesses to have an impact on profitability.  As for HPQ, they have had bad acquisitions but there core business has been strong enough for them to overcome these mistakes.  So in a sense despite bad management, they still made out (one definition of a moat).  However, if DELL had made a similar set of mistakes they would most likely be toast.  I think DELL has a great management team with a large number of OK business and a few good businesses.  Even though I do have to admid M. Dell has done a great feat for the cards he has been dealt and when DELL was trading at a discount to CSCO and MSFT, I would have invested also.  For my taste today, I would rather stick with MSFT and CSCO where you have both effective management and good businesses and prices comparable to DELL.

 

Packer 

[Guest VAL9000]

Here is a question for DELL fans, Dell has gone away from its build to order model to the traditional model of build and then sell in emerging markets.  If you look at the payables in DELL balance sheet, you will see it declining every year.

Shalab, not sure what the question is here but I think it's along the lines of why they are abandoning the build to order model in emerging markets.  My view is that the build to order model matters less and less.  When I was a kid, I remember salivating over the back-cover Dell ads in PC World magazine.  I'd take my little calculator out and figure out how much it would cost to buy the best performance PC you could configure.  It used to be like $4-5k - and that was the best price you could get for those specs.  When I got a little older and started off in university, I custom-built my own PC.  I scoped out everything and put it together in my basement.  It was awesome - dual overclocked celerons, 18 GB HD, 128MB RAM, a 32MB video card! and a first generation DVD player.  It cost me around $2k and it was easily the best rig in my dorm (I went to a nerd school).  My next PC I bought online.  I picked the parts and they shipped it pre-assembled.  Cost me $800 or something.  My last few PC's, I just picked whatever was in my price range.  I don't even look at the hardware.  I just stopped caring about what specifically is in it.  Maybe it's because I'm getting old, but I think it's because it just doesn't matter.  There are zero applications outside of a few  high-end graphics-intensive uses that won't run on any PC that you buy from Dell today.

 

With the hardware specs mattering less and the cost of hardware dropping, there's limited reason to offer a customized computer option.  The savings that people gain from customizing their PC's are outweighed by the savings Dell can create by just offering a dozen different set models.

 

The custom server thing still makes sense, because that hardware can range from $500 to $500,000 for a single unit.

 

There are signs of this hardware apathy in other markets, too.  Without looking, does anyone know the hardware specs of their tablets or smart phones?

 

I'm getting interested enough in Dell to take a hard look.  All this talk about it is getting me nostalgic about my PC World days.

[Guest VAL9000]

Shalab, not sure what the question is here but I think it's along the lines of why they are abandoning the build to order model in emerging markets.  My view is that the build to order model matters less and less.

 

You answered one of the questions about Dell moat ( or lack there of )  ;D

LOL - that's one way to look at it!  Another way to look at it is to say that Dell is just retooling their competitive advantage as lowest-cost-provider on the PC side.  The old model was that they could assemble your exact PC requirements and ship it to you at a lower cost than their competitors.  Now that hardware pricing is converging, the incremental cost savings of 200GB HD vs. 250GB HD aren't significant relative to the cost of providing all of those options.  So they're consolidating models because it's less expensive to supply 1,000,000 PCs with 12 variations vs. 1,000,000 PCs with 5,000 variations.

 

But yeah, the advantage they enjoy with their world-beating supply chain is being marginalized.  Again, on the PC side only.

[goldfinger]

Shalab, not sure what the question is here but I think it's along the lines of why they are abandoning the build to order model in emerging markets.  My view is that the build to order model matters less and less.

 

You answered one of the questions about Dell moat ( or lack there of )  ;D

LOL - that's one way to look at it!  Another way to look at it is to say that Dell is just retooling their competitive advantage as lowest-cost-provider on the PC side.  The old model was that they could assemble your exact PC requirements and ship it to you at a lower cost than their competitors.  Now that hardware pricing is converging, the incremental cost savings of 200GB HD vs. 250GB HD aren't significant relative to the cost of providing all of those options.  So they're consolidating models because it's less expensive to supply 1,000,000 PCs with 12 variations vs. 1,000,000 PCs with 5,000 variations.

 

But yeah, the advantage they enjoy with their world-beating supply chain is being marginalized.  Again, on the PC side only.

 

Dell's business is changing fast and what you describe is the past. Almost half of Dell employees work in services now!

Dell is opening offices in the Silicon Valley so as to augment its software solutions while optimizing its low margin businesses by outsourcing opportunistically. The build to order model is now only one smaller part of the offering. This is definitely not a business

with super strong moats and coke like franchises but its strength comes from multiple advantages combined together:

- a brand name and a resilient reputation for selling good low cost hardware.

- super efficient distribution channels.

- very good understanding of customer needs (a la WalMart).

- positioning to serve smaller structures (HP and IBM are competing in the large scale areas - large institutions).

- completeness and relevance of the offering: combination of hardware/software-security/services/cloud/storage + partnerships (for network offering with Cisco for example).

- relevance of the old model for servers and appliances and network and still for PCs in certain cases.

- marketing and presence.

- scale.

 

People who play with hardware like you are a minority and do not represent the mass. Enterprises do not have time to play like this

and they are looking for certain combinations of features.

 

As a reference:

http://bits.blogs.nytimes.com/2011/05/02/dells-future-beyond-the-pc-business/

[ERICOPOLY]

Longleaf Partners Fund is what you might call the Navy SEALs of the financial world -- an elite group that shuns the spotlight while performing incredible feats where others fear to tread.

 

Their performance vs S&P 500:

15 year  +2.2%

10 year  +2.25%

  5 year  -1.01%

  3 year  -2.31%

  1 year  -2.42%

[ERICOPOLY]

For my taste today, I would rather stick with MSFT and CSCO where you have both effective management and good businesses and prices comparable to DELL.

 

DELL has $2.20 per share non-GAAP forward earnings if the latest quarterly numbers are to be maintained.  That's I think where DELL is much cheaper than MSFT and CSCO.  Time will tell.

[txlaw]

My view is that it is too simplistic to talk about moats (or a lack thereof) when we're talking about a company that has been undergoing a transformation for a while now (successfully, I might add, IMO).  It makes more sense to talk about competitive advantages, threats to existing businesses, and growth prospects.  We have to think about the company holistically.  The same is true of an analysis of MSFT, where the moats of the cash cow businesses are shrinking but where free cash is being deployed into other businesses or into transformation of the cash cows.

 

The analogy to IBM is very appropriate -- Michael Dell has been gunning for IBM for a while now.  Dell, which has always focused on its business customers despite having a great consumer business in the past, sells productivity to its enterprise customers.  Like IBM, the goal is to help solve business problems using technology.  I highly recommend reading the Economist article discussing the longevity of IBM over the last 100 years.  Much of what is in that article is instructive with regards to DELL's prospects.

 

By far, the greatest competitive advantage DELL has is its customer relationships and distribution network.  DELL directly talks to business and government in order to understand their needs and it develops solutions, whether hardware-, software- or services-oriented, for these customers.  This distribution channel (which provides info on a two-way basis) is extremely valuable.  It allows DELL to buy companies like Compellent at what appear to be high prices, scale up the sourcing for these acquired product lines, and then dramatically increase units sold by selling through the distribution network.  All of a sudden, the price paid doesn't look so high.  

 

It also allows DELL to sell both commodity hardware and high margin services to its customers.  Case in point: "The Nuclear Regulatory Commission (NRC) has selected Dell’s wholly-owned subsidiary, Perot Systems Government Services (PSGS), a unit of Dell Services, to provide a full scope of Information Technology Outsourcing (ITO) support services as well as hardware, enterprise, and software products."  See how the entire package was sold to the NRC?

 

The strength of this network is also increasing on a worldwide basis.  Dell is the number one PC-brand in India.  How quickly we in NA forget that PC penetration is nowhere near complete in emerging markets!  By dealing directly with Indian business, DELL strengthens its customer relationships and prepares for a future where they can sell other things to those Indian businesses (mobile devices, cloud hardware, consulting services).  Same is true in Brazil and China.

 

Scale is also an advantage to DELL.  Being a big seller of commodity hardware means that it has created a supply chain with manufacturers all over the world that cannot be duplicated easily and that allows it to be a low-cost provider of hardware (though not necessarily the lowest-cost provider).  The low-cost/direct buy supplier advantage is still fruitful today in the enterprise segment (much less so in the consumer segment) and in the cloud infrastructure segments, which provide the guts for the productivity shift that is going on today with the move to the cloud.

 

The scale and supply chain has allowed DELL to deploy free cash into building a cloud hardware product line that a has a long runway ahead of it.  Many of the cloud infrastructure providers we like to talk about a lot use Dell hardware.  Many that we do not talk about also use Dell hardware.  For example, I've noted on the board that Tata is partnering with Dell to bring out its own IaaS service in Singapore and India.  Dell and HP are trying to further strengthen their market positions here by working with the OpenCompute project so that they can help build hardware and data centers that allow developers and platform providers to focus on just that, and not have to worry about hardware at all.

 

Finally, there is also know-how and innovation.  Dell hasn't been known to be innovative in the past, but is becoming more so, especially in the cloud hardware segment and in the services segment.  DELL is also snapping up IP related to its cloud hardware businesses and has vowed to continue to focus on IP.

 

I think it's useful to break DELL up into its varying businesses, all of which do actually work synergistically to strengthen its customer relationship network.

 

Consumer PCs -- Declining competitive advantage here because the lowest-cost/direct buying edge that DELL used to have matters less and less . But note that less than 10% of earnings come from this segment

 

Enterprise PCs and hardware -- Still has a competitive advantage due to customer relationship network and low-cost supply chain.  Margins continue to decrease though.  

 

Cloud infrastructure hardware -- Scale matters and there is a very long runway for growth here.  Buying up IP allows DELL to prepare for a high volume future where margins are pretty decent despite being in the hardware biz

 

Services, software, and consulting -- High margin and low penetration at the moment.  Will be much bigger profit center in the future.

 

Finally, a huge additional benefit: the management team and Michael Dell.  These guys have been doing a great job with the transformation, they are extremely shareholder friendly, and they work as a team.  They understand that they need to focus on business and understand what business needs.

 

------

 

Some additional anecdotal evidence that might interest some of you.  I happen to live in Austin, TX, so I will often run into people who work at DELL, which is based in Round Rock.  Morale was very low there a couple years back, but recently, everyone I've talked to who works at DELL has said that morale has really improved, along with the work environment and the business prospects.

 

That's a good thing to hear from those folks.

[goldfinger]

My view is that it is too simplistic to talk about moats (or a lack thereof) when we're talking about a company that has been undergoing a transformation for a while now (successfully, I might add, IMO).  It makes more sense to talk about competitive advantages, threats to existing businesses, and growth prospects.  We have to think about the company holistically.  The same is true of an analysis of MSFT, where the moats of the cash cow businesses are shrinking but where free cash is being deployed into other businesses or into transformation of the cash cows.

 

The analogy to IBM is very appropriate -- Michael Dell has been gunning for IBM for a while now.  Dell, which has always focused on its business customers despite having a great consumer business in the past, sells productivity to its enterprise customers.  Like IBM, the goal is to help solve business problems using technology.  I highly recommend reading the Economist article discussing the longevity of IBM over the last 100 years.  Much of what is in that article is instructive with regards to DELL's prospects.

 

By far, the greatest competitive advantage DELL has is its customer relationships and distribution network.  DELL directly talks to business and government in order to understand their needs and it develops solutions, whether hardware-, software- or services-oriented, for these customers.  This distribution channel (which provides info on a two-way basis) is extremely valuable.  It allows DELL to buy companies like Compellent at what appear to be high prices, scale up the sourcing for these acquired product lines, and then dramatically increase units sold by selling through the distribution network.  All of a sudden, the price paid doesn't look so high.  

 

It also allows DELL to sell both commodity hardware and high margin services to its customers.  Case in point: "The Nuclear Regulatory Commission (NRC) has selected Dell’s wholly-owned subsidiary, Perot Systems Government Services (PSGS), a unit of Dell Services, to provide a full scope of Information Technology Outsourcing (ITO) support services as well as hardware, enterprise, and software products."  See how the entire package was sold to the NRC?

 

The strength of this network is also increasing on a worldwide basis.  Dell is the number one PC-brand in India.  How quickly we in NA forget that PC penetration is nowhere near complete in emerging markets!  By dealing directly with Indian business, DELL strengthens its customer relationships and prepares for a future where they can sell other things to those Indian businesses (mobile devices, cloud hardware, consulting services).  Same is true in Brazil and China.

 

Scale is also an advantage to DELL.  Being a big seller of commodity hardware means that it has created a supply chain with manufacturers all over the world that cannot be duplicated easily and that allows it to be a low-cost provider of hardware (though not necessarily the lowest-cost provider).  The low-cost/direct buy supplier advantage is still fruitful today in the enterprise segment (much less so in the consumer segment) and in the cloud infrastructure segments, which provide the guts for the productivity shift that is going on today with the move to the cloud.

 

The scale and supply chain has allowed DELL to deploy free cash into building a cloud hardware product line that a has a long runway ahead of it.  Many of the cloud infrastructure providers we like to talk about a lot use Dell hardware.  Many that we do not talk about also use Dell hardware.  For example, I've noted on the board that Tata is partnering with Dell to bring out its own IaaS service in Singapore and India.  Dell and HP are trying to further strengthen their market positions here by working with the OpenCompute project so that they can help build hardware and data centers that allow developers and platform providers to focus on just that, and not have to worry about hardware at all.

 

Finally, there is also know-how and innovation.  Dell hasn't been known to be innovative in the past, but is becoming more so, especially in the cloud hardware segment and in the services segment.  DELL is also snapping up IP related to its cloud hardware businesses and has vowed to continue to focus on IP.

 

I think it's useful to break DELL up into its varying businesses, all of which do actually work synergistically to strengthen its customer relationship network.

 

Consumer PCs -- Declining competitive advantage here because the lowest-cost/direct buying edge that DELL used to have matters less and less . But note that less than 10% of earnings come from this segment

 

Enterprise PCs and hardware -- Still has a competitive advantage due to customer relationship network and low-cost supply chain.  Margins continue to decrease though.  

 

Cloud infrastructure hardware -- Scale matters and there is a very long runway for growth here.  Buying up IP allows DELL to prepare for a high volume future where margins are pretty decent despite being in the hardware biz

 

Services, software, and consulting -- High margin and low penetration at the moment.  Will be much bigger profit center in the future.

 

Finally, a huge additional benefit: the management team and Michael Dell.  These guys have been doing a great job with the transformation, they are extremely shareholder friendly, and they work as a team.  They understand that they need to focus on business and understand what business needs.

 

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Some additional anecdotal evidence that might interest some of you.  I happen to live in Austin, TX, so I will often run into people who work at DELL, which is based in Round Rock.  Morale was very low there a couple years back, but recently, everyone I've talked to who works at DELL has said that morale has really improved, along with the work environment and the business prospects.

 

That's a good thing to hear from those folks.

 

You went into the details and I like your explanations. The analogy with IBM is effectively very good and Dell's niche is the smaller business.

Thanks TxLaw.

[goldfinger]

For my taste today, I would rather stick with MSFT and CSCO where you have both effective management and good businesses and prices comparable to DELL.

 

DELL has $2.20 per share non-GAAP forward earnings if the latest quarterly numbers are to be maintained.  That's I think where DELL is much cheaper than MSFT and CSCO.  Time will tell.

 

They are expecting 5% to 7% revenue growth with rapidly increasing operating margins for the foreseeable future. And Dell has put his money where his mouth is even though he invests most of his money in a proprietary diversified hedge fund. So I believe some of what they say.

[goldfinger]

Many of the HPQ businesses are actually in deep trouble...

 

Munger would you mind giving more details on where exactly those businesses are in big trouble?

[Munger]

Munger would you mind giving more details on where exactly those businesses are in big trouble?

 

 

I am not aware of any of their business that aren't struggling.  The company has been poorly managed.

 

This week's Barron's provides an example.

 

The spat between long-time partners Oracle and Hewlett-Packard is personal, and it's getting nastier.

 

The latest in this ongoing melodrama is the Hewlett-Packard (ticker: HPQ) lawsuit filed last week against Oracle (ORCL), accusing it of breaking a longstanding agreement and defaming HP in the process. At issue is Oracle's March announcement that it will no longer provide database support for the Intel (INTC) Itanium microprocessor that's used in high-end HP servers.

 

Oracle's core business was always software—for decades, big databases, then an arsenal of corporate-application software it amassed through acquisitions. HP, in the corporate market, has been mostly a hardware heavy—and the supplier of Itanium-powered servers to some 140,000 big business customers. The two companies' complementary offerings made for a near-perfect partnership.

 

Then things changed. Itanium never really lived up to its promise, as corporate computer users embraced another more popular microprocessor architecture, called x86. Intel developed the original x86 architecture, but competitors, such as Advanced Micro Devices (AMD), helped push x86 servers to the forefront of the business, at first at the lower end of the server market, then in progressively more advanced servers. Meanwhile, HP's high-end Itanium line competed directly with Unix servers based on a super-fast chip developed by Sun Microsystems, called Sparc. Then Oracle bought Sun, giving it a foothold, and a substantial business interest, in hardware for high-end servers.

 

To be sure, Oracle's announcement that it will not provide support for Itanium servers will eventually mean that customers wanting to upgrade to Oracle's newest databases will have to buy non-Itanium servers, which presumably could include Sparc servers from Oracle. In its lawsuit, HP is calling this move by Oracle, once its arm-in-arm partner, anti-competitive. Oracle responds that Intel was eventually going to phase out Itanium in favor of its x86-based Xenon chips anyway, and it argues that HP—as the most important user of Itanium processors—knew about this, but did not raise the issue with Oracle.

 

In a statement responding to the lawsuit, Oracle described the situation this way: "In September of 2010, HP asked Oracle for a long-term commitment to support Itanium. At that time Oracle did not know that there was a plan already in place to end Itanium's life. Oracle did not learn about that plan until six months later, in March 2011." According to Oracle, the key to the spat is that when HP specifically asked for long-term support of Itanium in September, Oracle declined to make that promise. HP has filed a lawsuit anyway, contending that Oracle is still obligated to support HP's high-end server line.

 

REGARDLESS OF WHAT HP AND ORACLE KNEW, and when they knew it, HP's server business will be the biggest loser. To be sure, corporate-enterprise technology is a cut-throat business, and it becomes no less bloody when former partners are constantly taking each other to court.

 

Oracle Chief Executive Larry Ellison stirred up a hornet's nest at HP by hiring former HP chief executive Mark Hurd. But lest we forget, at the time of the hiring, the HP board had already fired Hurd. The guy was out of a job. Of course, HP punched back by hiring Ellison's former No. 2, Ray Lane, as its non-executive chairman, and Leo Apotheker as CEO. As a former CEO of German software giant SAP, which is Oracle's largest competitor, Apotheker was public enemy No. 1 in the eyes of Ellison & Co.

 

These people really hate each other, and you can't make this stuff up.