Dell (
DELL
) competes with personal computer manufacturers like HP (
HPQ
), Apple (
AAPL
), Acer (TPE:2353) and Toshiba, and increasingly against IBM (
IBM
) and others for IT services.
We estimate that Dell generates roughly 22% of its stock value
through its desktop and notebook/netbook operations. Although
our current price estimate for Dell at $19.25
stands well above the current market value, we highlight four
reasons to be cautious regarding the company's outlook.
1) Lower Margin Outlook
Competition in the notebook and desktop business has intensified
as more competitors move into this business. Over the years, Dell
has lost share in the PC business to HP and Acer and we
foresee a decline going forward given increasing popularity of
Apple's Mac notebooks. As PC sales are pressured and fixed costs in
the manufacturing business continue to remain high, Dell could see
lower profit margins in the future.
The chart below examines Dell's stock price sensitivity to
changes in profit margin, the amount of revenue that flows
through to operating profit, for its notebook and netbook
segment.
2) Broader Slowdown in Technology Sector
An overall slowdown in IT spending by businesses could hurt both
Dell's hardware and services businesses. Although not included in
our base case forecasts, Cisco's (
CSCO
) weaker than expected earnings have prompted concern regarding a
broad slowdown in technology spending.
Contract notebook manufacturers are also running below
expectations, a possible sign of weak notebook demand. As we
approach the holidays, the personal consumer segment for PCs
typically picks up. If this disappoints, we could see a broader
pullback in the tech sector.
The chart below examines Dell's stock price sensitivity to
changes in global netbook and notebook demand.
3) Increased Focus on Services Business
Dell's services business, which we estimate accounts for roughly
23% of its stock value, has been the company's biggest value driver
over the past few years. However, it is not Dell's traditional
business and strategic mistakes here could be costly. Further, if
the recent strength in IT budgets among corporations does not hold
up (as the company currently expects) services revenue could
decline.
The chart below examines Dell's stock price sensitivity to
changes in consulting and other services revenue.
4) Significant Expenditures to Support Business
Growth
Dell is also planning to spend significantly to expand its PC
business, especially in China, reporting that it will spend $100
billion in the next decade. Whether this investment will ultimately
pay off is unclear. In the meantime, such heavy capital expenditure
will erode Dell's free cash flows.
See our complete analysis for Dell's stock is
here