Dell Technologies financial analysis

Part I. Company Overview
Dell Technologies Inc is a computer designer and marketer based in Hopkinton, MA. Dell is the third-largest computer hardware company by global market share. It holds a share of 15.9%, trailing HP (21.8%) and Lenovo (20.4%), but ahead of Apple (7%) and Acer (6.8%) (Dunn,2017).
Dell Technologies was created with the merger of Dell Inc and EMC Corporation. Dell Inc was founded by Michael Dell in 1984 in his dorm room at the University of Texas at Austin. The company's products were an immediate success, and by 1986 it opened a factory in Austin. The company rose to prominence in the industry, and by the time the Internet was born Dell was already a major computer manufacturer; the Internet boom allowed the company to launch into hypergrowth. Dell computers were for many years only available via ordering; there was no in-store distribution. This allowed the company to let consumers customize their own machines, something that appealed substantially in the marketplace. Foreign competition changed the dynamic of the computer hardware industry, with low-cost alternatives squeezing out some of the major players.
Dell's fortunes wavered for a time, the company losing market share. In 2015, it acquired data storage system maker EMC for $67 billion. This deal led to the creation of the current company, Dell Technologies, which competes in a number of related industries including information storage, backup and recovery, virtualization, security, cloud and of course computer hardware. The acquisition gives some context as to how to value Dell, not just by setting a price but also by bringing Dell's organization more in line with that of Hewlett-Packard, a major competitor in a number of different businesses.
The company is still working in the merger at this point. The 2017 fiscal year was really the first fiscal year with the merger, and even at that point the two companies were operating largely independent of one another. It can be a shock to integrate large, established companies too quickly, and it appears that Dell is taking a conservative path with this merger so as not to make any critical mistakes. So at this point, the merger itself is reflected in the company's finances, but most of the post-merger integration of the two companies does not appear to have taken place. This is also reflected in the financials of the company – Dell still is unprofitable and has not done a whole lot of cost-cutting to change that, perhaps hoping that there will be revenue synergies and that cost-cutting might only take place a little further down the line.
Part II. Microeconomic Environment
Dell markets computers to both consumers and enterprise. It generally focuses on the mid-market and premium segments, as the low-end is populated by a number of relatively generic manufacturers. Most of the products on the EMC side are enterprise products that are marketed and priced at a premium.
Most products exist in a somewhat competitive state, but close to oligopoly, around 3-5 major competitors. By competing on mainly at the higher end of the market, and focused on enterprise, Dell works with its customers almost as partners, providing them with a range of services, especially since the merger. Dell is able to bundle technology and software packages, and prices on that basis. Its major customers have long buying cycles, and while cost is a factor, are not strictly driven by cost. The PC market is a little bit different, as the product is largely commoditized. Dell seeks to differentiate on the basis of having best-in-class machines, and pricing competitively against the other players. If one compares a specific product, like the XPS 13, against its peers the approach for Dell seems to be to price with the rest of the market, or slightly above, but deliver a superior computer.
Dell's cost structure is largely variable costs. According to the latest annual report, variable costs were 75% of the company's total cost structure. One of the main drivers of success, research and development, is actually one of the smaller line items for Dell.
For Dell, the ability to control the costs of doing business, and ensure that it can achieve its margin targets are important. Because of the degree to which Dell competes for enterprise business, a major competitive move like a new entrant or merger could have significant implications about the competitive landscape. The PC business changes frequently, but seasoned Dell executives are well aware of the highs and lows of competing in the consumer PC market, where Dell has risen and fallen more than once.
Part III. Macroeconomic Environment
The current macroeconomic situation in the US is interesting. In general macroeconomic indicators are positive, but many observers are signalling that there are signs of a bubble. Among the basic indicators, GDP growth is strong. Q3 2017 growth was at 3.3%, the fastest rate in three years (Mutikani, 2017). This indicates a bump, however, with the expectation that inventories will be depleted over the course of the next couple of quarters (Mutikani, 2017). Tightening labor markets are partly a sign of strong economic growth as well – the unemployment rate has been improving basically since 2009 and today stands at 4.1%, not far above the baseline level of systemic unemployment.
One interesting element is that real interest rates are negative, something that can definitely help to fuel growth, in particular in the form of inventory buildup in advance of an expected rate increase. Analysts believe that as many as three 0.25% hikes will be delivered by the Fed in 2018, to help cool the US economy (Ivanovitch, 2017). With economic growth picking up steam and interest rates still rock bottom and in need of a strong upward swing, the conditions today are similar to those in 2007, and economic analysts have expressed concern that we are close to a bubble (Clements, 2017).
The current tax plan that reduces corporate tax rates is probably the biggest piece of legislation that will affect Dell in the short run. Even with that, Dell has been running losses since the merger, and presently receives income tax benefit – a company with an effective tax rate of less than 20% stands to gain little from the proposal unless it becomes profitable, so in that sense even this change will not affect Dell. It might, however, make Dell's competitors more profitable.
Overall, the macroeconomic climate is generally favorable. Dell is definitely one of the companies that should benefit from increasing corporate spending. IT infrastructure is absolutely critical, and Dell's investment in EMC, which has several security-related products, should pay dividends if there are increases in cyberattacks that drive up demand for security products and consulting. On the whole, unless the economy actually does see a bubble burst, there are no red flags for Dell.
Part IV. Ratio Analysis
The key ratios for Dell are as follows:
2017
2016
Current Ratio
0.806949
0.931371
Quick Ratio
0.740396
0.867404
Debt / Equity Ratio
5.206271
29.70668
x Interest Earned
n/a
n/a
Gross Margin
21.02%
16.47%
Operating Margin
-5.28%
-1.01%
Net Margin
-2.71%
-2.17%
Inventory Turnover
10.17592
23.20136
Fixed Asset Turnover
10.9043
30.87386
Receivables Turnover
6.43758
10.41764
ROA
n/a
n/a
ROE
n/a
n/a
There are a few things that stand out from the ratios. First is the caveat that the company has not had an operating profit, much less a net one, during the past couple of years. So there are not ROA, ROI, ROE figures to report, and those respective margins are negative. The main point is then the gross margin, which improved from 16.47% to 21.02% in the year. This is attributable to the acquisition, as Dell before EMC was doing around16% of revenues in services, which have a higher margin, versus over 20% of revenue from service after the merger.
The second thing that one notices from the ratios is that certain aspects of the company changed quite a bit as the result of the merger. Most notably, the capital structure has transformed. Where the company prior to the merger had a debt/equity ratio of 29.7, it now has a debt/equity ratio of 5.2. This indicates that EMC was likely in a much better financial position than Dell at the time of the merger, which would be unusual, but it also shows that financially, the combined company is stronger. It has better margins, and while still not being profitable, has a more manageable debt load.
Also worth noting from the ratios is that the inventory turnover has lowered considerably, which is also a function of the merger. Dell has a fast inventory turn as its computers are typically made to order. EMC did not operate with this business model, so it carries inventories of its hardware, and so the merger caused the inventory turnover of Dell to shrink dramatically as its inventory levels increased. While the liquidity ratios are worse, this change is not significant. Dell's times interest earned could not be calculated because of its operating losses.
Part V. A pro forma income statement for the next annual accounting period cannot actually be done, because the merger means that there are no meaningful trends to be extrapolated from the prior two years – the business is completely different year over year so the trends you pull from the numbers are meaningless. The upside is that Dell has completed three quarters of current fiscal year, so most of those numbers actually exist. This makes it less a pro forma but we can extrapolate the next annual accounting period:
Income Statement
FY 2018*

Revenue
77.80

COGS
58.77

Gross Profit
19.03




R&D
4.63

SGA
19.16

Operating Profit (Loss)
-4.76




Net Profit (Loss)
-4.79



The first three quarters have already been reported, but the fourth is the biggest of the fiscal year, and gains over last year were projected at 5%. There is not much evidence of strong cost cutting yet, so it was assumed that costs would grow around the same as sales This shows that Dell is continuing the lose money, and continues to run at an operating loss, even with the merger.

Part VI. CAPM
The capital asset pricing model is a means by which the company's cost of equity can be determined. It is comprised of the risk free rate, the market risk premium and the company-specific risk premium, which is the beta (Investopedia, 2018). Dell's new stock has only been on the market since the merger, so there has not been enough time for agencies to calculate a beta. Without access to a beta, one can only assume a beta of 1.0.


Source: Investopedia (2018)

Ra = 2.5 + 1.0(8)
Ra = 10.5%

Dell's cost of equity can therefore be set at 10.5%
The reality is that Dell's beta is probably higher than one, but only a little bit. One could instead choose a close competitor as a something of a proxy beta, or even a basket of competitors if there are that many. HP is obviously the most natural competitor. HP has a beta of 1.85, which is quite high. The company also has a different financial structure than Dell, featuring negative equity, so it might not be as good a proxy as it seemed. Nevertheless, if we plug in the HP beta we get 17.3% as the cost of equity, or expected return on the equity in the long run. That is actually quite a bit closer to the analysts' projected growth for Dell (see later) than the baseline 1.0 beta.

Part VII. Dividend Growth Model
One valuation methodology is the dividend growth model. This model carries with it the assumption that dividends are the only reason why investors buy a company – they pay for dividends and assume no capital gains. This is an entirely unrealistic assumption, especially when the company does not pay dividends. Dell does not pay dividends.
The current price of Dell stock is $88.49. However, because of the underlying assumption that a stock is only worth the present value of its future dividend payments, any company that does not have dividends is assumed to have a value of zero. There is a feeble argument about expected future dividends, but Dell has not paid a dividend since 2013, and that was a fairly miniscule one. There is no reasonable expectation that a company with a negative EPS and flimsy history of paying dividends is ever going to pay one. By the logic of the dividend growth model, Dell's value is zero, which is $88.49 less than what it trades for.
Furthermore the long run growth rate cannot be calculated. Let's solve:

P = D / (k-g)
88.49 = 0 / (.105- g)
9.29g -0 = 0
9.29g = 0
g = 0

No long run growth rate is projected – the model cannot account for a company that pays no dividends. For a company like Dell, where there is clearly upside, but no indication that this upside is going to take the form of dividends, the model offers little insight. The reality is that there are many companies now that do not pay dividends. Even a company like Apple didn't want to pay dividends until it had so much cash that its shareholders basically forced it to. In the hardware space, Dell might never be so profitable that it would be compelled by shareholders to pay dividends. A model that accounts for capital gains would be more appropriate to analyze a company like this, because investors in Dell are clearly seeking capital gains.

Part VIII. Analysts
On the Yahoo Finance table, there is only one analyst covering Dell Technologies. This is a bit strange, but it is what it is. Our not-statistically valid sample size of one gives a five-year estimated growth rate of 24%. This is a much greater growth rate than that projected by the dividend discount model, for obvious reasons. It is also a greater growth rate than the company's cost of equity, as calculated in the CAPM.
There are several reasons why these values differ. For one, it's garbage in garbage out. Bluntly, the dividend growth model can't handle a company that doesn't pay dividends, and the estimate of only one analyst is not a whole lot more informative. But it is at least a little bit better. So, in that, we see that the analyst has taken a much more bullish note on the company. There are a few possible reasons why this analyst is generally positive about Dell. First, the restructured company is healthier financially. Dell Computer was highly leveraged, and the new company is not. The combined entity has multiple revenue streams, which will help Dell weather the next storm in personal computers better than it fared in the last one. The move is also strategically valuable, giving Dell the sort of suite of products it can use to compete. Rivals like HP and IBM also offer suites of packages to their enterprise clients, and Dell is closer to competing on this regard. The move helps Dell's competitive position going forward.
The combination of better financial health and better competitive positioning is reason for optimism for someone looking at Dell. One could make the case that at $88.49, Dell has already priced in a lot of that optimism, especially in line of its persistent losing of money. However, the optimism itself is not misplaced, giving how the microeconomic, macroecomic and company-specific factors align. The EMC acquisition appears to have put Dell in a positive position.
This analysis overall would be better if there were more analysts. With just one, you really do not have a consensus, and it can be difficult to tell if this is the most bearish or the most bullish on the company's prospects. There must be other analysts covering Dell, but for whatever reason they have not yet been picked up by Yahoo Finance. Still, with more opinions, it would be a bit easier to get a growth rate that is widely agreed upon, and then compare that with the implied growth rate.

Part IX. CFO
I would love being the CFO of Dell. First, that's a great job with a fairly prestigious company, and doubtless it pays better than what I make now.
But as for the job itself, there are a lot of good reasons to want the gig. First, there is the matter of the ongoing merger. The merger has completely altered Dell's capital structure, and this has implications across the board. Finance at Dell is not incremental – as noted a few times in this report there are not always strong baselines to compare performance pre- and post-merger. That alone creates a challenge with respect to things like setting KPIs and budgeting.
Second, Dell is presently facing a challenge with respect to finding profitability. The merged entity is healthier in many respects, but it still faces ongoing operating losses. The CFO is going to be part of the team that is working to resolve these challenges, by identifying areas of opportunity to cut costs, and bring them in line with industry norms, or targets that worked well for one of the predecessor companies. There is a lot of work to be done internally, and analysis provided by the CFO's team will go a long way to helping the operations people identify targets for improvement. It is not everyday that Finance can have such a strong influence over how a company is run, but post-merger is definitely one of those scenarios.
A third reason why it would be desirable to be the CFO of Dell is that the company has an opportunity through its restructuring to set a new course with respect to things like dividends, and a new path. The company was created through the merger, and the shareholders in general are people who would have either owned one of the predecessor companies, or specifically bought in post-merger. The valuation is high, which is good for current shareholders, but this also reflects a market that has been fairly strong anyway over the past several years. Dell at this point probably needs to position itself financially to weather a market storm. Even if such storm does not materialize, the reality of how Dell never really bounced back all the way from 2008 has to be considered here, and the CFO will work closely with the CEO in order to get the company ready for the next bubble burst, whenever that might happen.
The other big thing is that Dell is integrated a number of different products lines, and has a much more complex operation as a result. There is a reason they kept the EMC CFO – that role was more similar to the role in the combined company. At the end of the day, taking two very large companies and putting them together into something that will be able to compete with HP, IBM and maybe someone like SAP is quite an undertaking.
This also means that Dell is probably not finished building itself out. After a couple of years, when EMC and Dell have more fully integrated, there will likely be further mergers and acquisitions. If you're the type of CFO who loves the challenge of structuring M&A activity, then it is quite likely that Dell will offer more opportunities in that area going forward – if it truly wants to go big in the enterprise space it will need to add more product lines, and that will create even more financial complexity.
What all this means is that there are a lot of moving pieces for Dell. The company presents a fantastic opportunity for a CFO, and as such I would be all in for the job. You could do better, but you are more likely to do worse. I assume we'll be doing several rounds of interviews, so we'd better get started.







References

Clements, L. (2017). Financial crash warning: 10 years on from 2007 crisis experts warn debt bubble could burst. Reuters. Retrieved January 19, 2018 from https://www.express.co.uk/finance/city/838947/Financial-crisis-US-economy-news-2017-similarities-debt-2007

Dell 2017 Form 10-K. Retrieved January 19, 2018 from https://investors.delltechnologies.com/sec-filings/sec-filing/10-k/0001571996-17-000004

Dunn, J. (2017) Here are the companies that sell the most PCs worldwide. Business Insider. Retrieved January 19, 2018 from http://www.businessinsider.com/top-pc-companies-sales-idc-market-share-chart-2017-4

Investopedia (2018) Capital asset pricing model. Investopedia. Retrieved January 19, 2018 from https://www.investopedia.com/terms/c/capm.asp

Ivanovitch, M. (2017). The Fed is hopelessly behind the curve if it wants monetary nirvana. CNBC. Retrieved January 19, 2018 from https://www.cnbc.com/2017/12/17/interest-rates-fed-faces-tough-road-on-federal-funds-rate-inflation.html

Mutikani, L. (2017) US third-quarter economic growth fastest in three years. Reuters. Retrieved January 19, 2018 from https://www.reuters.com/article/us-usa-economy-gdp/u-s-third-quarter-economic-growth-fastest-in-three-years-idUSKBN1DT1W7

Yahoo Finance (2018) Retrieved January 19, 2018 from https://finance.yahoo.com/quote/DVMT/analysts?p=DVMT