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Dell’s Earnings Reveal the Future

A number of analysts have declared this time the Post-PC Age and while I agree that that age is inevitable, I do not think it’s here yet.  Dell Computer (NASDAQ:DELL) posted very disappointing earnings for the first quarter of 2012 yesterday that had as much to do with the global-macro reality than it did with any structural changes to the PC industry. 

Let’s not kid ourselves, Dell can make money selling tablets the same as Acer or Asus.  That’s not the issue at this point.  The question to ask is why would they want to?  Dell’s results are yet another example of the deterioration of the U.S. economy that can no longer be papered over with economic statistics and headlines of blow-out Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) earnings.  American consumer business was off 12%.   

Makeover Candidate

Dell is actively remaking itself into a server and IT services company moving away from the thin and vanishing consumer electronics market.  Their consumer business accounts for only 20.7% of their revenue but only 3.9% of their income.  At this point Dell could stop selling computers to consumers and nothing about the company’s futures growth prospects would change.  If anything the PC business is a boat anchor dragging down the company’s return on invested capital.

Hewlett-Packard (NYSE:HPQ) finds itself in the same boat, but, unlike Dell new CEO Meg Whitman still sees the potential for the consumer market but it will come in the form of streamlining operations further and producing fewer models at fewer price points.

Dell’s Enterprise Solutions now accounts for 49% of operating income with 9.2% net margins.  And that’s the best part of that news, considering that revenue was down 3% over 4Q 2012.  Again, it cannot be stressed enough, that this is not about Dell in specific but a problem with the U.S. in specific.  China’s overall sales grew 9%, while overall business in the Americas dropped 7%. 

Price Compression

The shocking number, though, for Dell was their performance in India.  Dell refused to even bid on a major government contract of 900,000 laptops for approximately $260 each.  While it would have looked good for the top-line revenue units sold numbers, it would have done Dell no good to fill the order.  With the Indian Rupee devaluing 20% in the past 3 months versus the U.S. Dollar that contract alone would have torpedoed Dell’s next earnings report, costing as much as $47 million in lost revenue from currency conversion alone.

In a way this is very similar to the make-over strategy for Flextronics (NASDAQ:FLEX) who is also moving away from consumer electronics and broadening their manufacturing and design base towards longer product cycle business in automotive and medical technology.

Dell announced during the quarter that sales of Ultrabooks had been three times stronger than they had anticipated.  These sales did not come from the consumer space but rather from the SMB (Small and Medium Business) and Enterprise verticals.  Powerful, long-lived laptops and tablets will continue to replace desktops and workstations as more and more computing prowess is moved to the cloud and more computation is outsourced.

Price will become an even bigger driver, though, as will graphics capability.  We are reaching the upper limit of personal computing power needed to perform the tasks most of us need to perform.  The real gains will be made on the back-end.  Whoever has the best solutions there will dominate the sector.

Going Smaller to Get Bigger

From this quarter’s results and 2011’s it looks like Dell’s best business is in providing solutions for smaller businesses.  It is the only portion of their business that grew in the first three months of 2012, 4%.  It’s hard to see Dell compete with the likes of IBM and HP at the large enterprise level and gain significant market share.  But, in the small business service space where HP and IBM are not focused Dell has a significant advantage in providing service and solutions that are lean and responsive.  Dell’s services division saw the highest growth rates, 23% and 17% for server installations.  This is where Dell will pick up business.

No one in the industry, including Dell, is expecting Microsoft’s (NASDAQ:MSFT) Windows 8 to be the salvation of PC makers.  Businesses do not upgrade their hardware because of a new Operating System.  They are usually the biggest laggards.  If anything, it is the changes to operational structures that will drive Windows 8 sales as businesses move to a higher percentage of mobile devices organization-wide.  The biggest gains will be made in the markets with the highest growth rate of new businesses as they will drive the demand for the new platform.  Hence, Dell’s growth in the short term will come from Asia Pacific and the BRICS nations and their millions of entrepreneurial ventures.

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Peter Pham is an author, international fund manager, and a registered financial director by the Cayman Monetary Authority (CIMA). In 2013 he published his first book entitled, The Big Trade: Simple Strategies for Maximum Market Returns. He currently manages the portfolio of a global hedge fund and runs an asset management company, Phoenix Capital.  (read more)

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