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When does a company that's projected to have $33 billion in sales this year with dominant market positions in several products have to worry about its ability to achieve 40% annual sales growth? When it's Dell Computer (DELL) -- and making a bid to enter the Internet Age.
Dell's 23% drop in value since its March high of 59 11/16 may seem a mere bruise compared with the bloodletting that many other tech stocks have experienced over the past two months, but other tech stocks aren't bellwethers for their sector. At its current price of 45 15/16, Dell is smack in the middle of its 52-week range. This is evidence of an uncertainty about Dell that reveals more than mere fears about tech stocks in general. Investors are questioning whether Dell can reposition itself to compete in a computer environment that relies more and more on the Internet for storage and data management, and less on the desktop PC that has made Dell a must-own tech stock.
SQUEEZING MARGINS.
Dell executives argue that the company successfully repositions itself all the time. Indeed, some 30% of its sales come from portable PCs, and 18% from what it calls enterprise technology that delivers Internet-based solutions for corporate information systems. Dell's plan is to rapidly increase its share of the Internet infrastructure market by delivering products that squeeze the fat margins in that business the same way Dell squeezed margins on PCs. By the end of this year the company will have unveiled several new pieces of Internet infrastructure hardware. But even if Dell successfully morphs into an infrastructure hardware provider, the days of 40% annual revenue growth may be over: Dell is just too big for investors to reasonably expect that kind of performance to continue. "Dell has grown out of its 40% growth capacity," says Walter Winnitzki, senior analyst at Chase H&Q, who adds that "$33 billion companies have a very difficult time achieving such growth.
"Normally they do, anyway. In its fiscal year 1999, ended Jan. 28, 1999, the company's revenues climbed 48%. Its fiscal 2000 sales of $25.3 billion represented a 38% increase over the previous year. The company's predictions of growth in the low 30% range for fiscal 2001 seem disappointing by comparison. But that's pretty eye-popping considering Dell's size.
"I haven't identified any $25 billion company in any industry that's growing at that rate," says T.R. Reid, senior manager of corporate public relations for Dell. "Lou Gerstner announced that the PC was dead, and since then, Michael Dell pointed out, 125 million have been sold.
"Dell's portion of those sales has been quite profitable, a Y2K-induced dip last year notwithstanding. The company's gross margins (net sales less cost of goods sold) were back up to 20.5% for the quarter ended Apr. 28, 2000. The trick to making money with these margins -- which are lower than those of competitors in proprietary technology businesses, such as Sun Microsystems -- is making it up on volume through Dell's low-cost Internet-based marketing model. It sells $40 million in computer hardware a day over the Net. That means it can keep inventories at a minimum, eliminating an entire layer of costs that still plague competitors such as Compaq, IBM, and Hewlett-Packard.
FIRST BUY.
Still, Dell's PC distribution story is old by now, and the market is awaiting its next feat of legerdemain -- its attempt to bring that model to its enterprise (Internet-based corporate computing) business. Skeptics say that Dell's slim inventory model will only work with commodity products, and that enterprise technology is anything but a commodity. "Dell gets its [281% fiscal 2000] ROIC [return on invested capital] because it can turn an asset faster than anyone," says Kevin McCarthy, an analyst at Donaldson, Lufkin & Jenrette, referring to Dell's inventory model. That's why Dell has done so well even as PC prices have dropped rapidly. "But enterprise technology is about people on site at the customer, holding the customer's hand, delivering mission-critical solutions with a much greater service and technical component," says McCarthy.
Dell's management is confident that it can turn its combination of customer relationships and Internet savvy into a successful Internet infrastructure business. Some 85% of Dell's business already comes from corporate clients, and its plan is to sell them the servers, NT workstations, and storage devices they need to create Internet-based systems. To this end, the company has introduced a line of caching servers that can be used to save space on Web sites by replicating frequently visited Web pages. The company began shipping these new servers in the current quarter and has other new servers in the pipeline.
Dell is already the No. 2 seller of servers worldwide. Although its total sales are only about two-thirds that of No. 1 Compaq, Dell's server business is growing faster than Compaq's. The latest product introductions appear to be helping. Dell added 5% to its share of the U.S. server market and 3% to its worldwide market share just in the first quarter of fiscal 2001. That compares with an increased market share in the U.S. of 10%, and 5% worldwide, for all of fiscal 2000.
"Dell has the opportunity to displace Compaq," says Don Young, an analyst at PaineWebber. "Its server business is growing at two to three times the rate of Compaq's.
"In an attempt to broaden its Internet infrastructure product line, Dell made a commitment to the storage market through its $330 million acquisition last year of ConvergeNet, a company that focuses on corporate storage area networks (SANs). This may not sound like a huge play, but the fact that it was Dell's first-ever acquisition is telling. ConvergeNet is developing a line of storage components that can be integrated with any other server or storage component. Unfortunately, the introduction of this new open architecture storage line has been pushed back three months, until the fall.
ALLIANCES WITH EXPERTS.
As for the service piece of the enterprise business, Dell is handling it through alliances with experts such as NaviSite, Interliant, and Exodus for Web hosting, Arthur Andersen and Gen3 partners for consulting, and Xuma and Lante for network design. The company projects that the global market for services and consulting for Web infrastructure will grow from last year's $12 billion to $71 billion by 2003. Dell's service revenues grew 60%, in the current fiscal year's first quarter, according to PaineWebber's Young.
For the Web access piece of Internet infrastructure, Dell is using its venture-capital arm, Dell Ventures, to invest in various application software providers (ASPs). The total Web access market should grow from last year's $37 billion to $117 billion by 2003, the company predicts.
The core of its business will always be hardware, however. "Dell is a hardware commoditizing animal," says Chase's Winnitzki. The company projects that the infrastructure hardware market will grow to $184 billion by 2003, vs. $74 billion last year.
Most analysts expect Dell's revenue in fiscal 2001 to hit roughly $33 billion. Chase's Winnitzki anticipates 2002 revenues of $43.5 billion, and he expects earnings per share to grow faster than revenues, from 88 cents in 2001 to $1.20 in 2002. He believes the shares will trade in the $60 range near term. DLJ's McCarthy believes the stock should trade in the $40 to $60 range. His EPS expectations for 2001 are higher than Winnitzki's at 95 cents, and $1.20 for 2002, on revenues of $42.5 billion. Salomon Smith Barney has a target price of $71 on the stock.
Who turns out to be right will depend on how Dell pulls off its current transition. "Management is smart. They know the game, and they're seeing the market shift. They spent about 2 hours 45 minutes of a three-hour analyst phone call talking about 18% of the business," says DLJ's McCarthy. Buying Dell at its current price could be a reasonable bet that management can turn that 18% into something much bigger.
Popper writes about the markets for Business Week Online
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Copyright 2000 , by The McGraw-Hill Companies Inc. All rights reserved.
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