PC Makers Are Today's
PC "box" makers were the talk of the Street today as a number of factors
converged to move the individual participants in the industry. Early this
morning, shares of GATEWAY 2000 (NYSE: GTW) opened higher after being
held and did not look back. News that the strike at United Parcel Service
(UPS) was over cleared up a black cloud that had hung over the direct computer
seller's head, as UPS is one of the company's main shipping partners. Gateway
2000 closed the day up $2 3/4 to $40.
Also affecting the computer manufacturers was the anticipation of DELL
(Nasdaq: DELL) quarterly earnings, released minutes after
the market closed. Analysts had been expecting $0.54 EPS, but Dell came through
with $0.59 EPS. Unfortunately, the so-called "whisper" numbers were looking
for $0.60 EPS, the highest estimate. Although the stock closed up $2 5/16
at $84 11/16, CNBC reported that the shares were down to $82 in after-hours
trading. With option volume on Dell at record highs heading to the close,
speculators looking to profit from an earnings surprise might be in for a
Over the next few days as investors digest Dell's quarterly report, the stock
may retrace any ground loss due to the unrealistic expectations set by traders
as the actual financials behind the quarterly earnings are quite impressive.
Contrary to the conventional wisdom talks about Dell's "commodity" business
and warns of "price squeezes," Dell's average selling price for its products
actually rose during the quarter as customers bought higher-end systems stacked
with more and more options. With higher prices and servers contributing a
record 8% of revenues, gross margins rose in the quarter to 22.2%, up from
22.1% last year. Many analysts had been anticipating that gross margins would
fall as the second quarter of 1996 was characterized by very favorable component
prices for Dell, making this meager 0.1% gain quite unexpected.
Going down the profit and loss statement, operating margins rose to 10.5%
from 8.9% last year. The company reduced operating costs by 1.6% in spite
of the fact that it added 1,600 new employees in the second quarter alone,
increasing headcount to 13,300, or 11.1%. The company's sheer need for manpower
to fuel its growth may be a future problem, but for right now growth in employee
costs apparently can barely keep up with the growth in revenues. Breaking
apart the operating costs, sales, general and administrative (SGA) expenses
increased 0.7% sequentially to 10.0% of sales, but the company's research
& development (R&D) expenses relative to sales dropped 0.3% to 1.7%.
The drop in R&D as a percentage of sales might signal a red-flag to many
investors used to companies that actually develop technology, but as a precision
electronics manufacturer, Dell is really in a different business than an
Intel or a Microsoft that need to spend on R&D. One of the advantages
of Dell's focus on computers instead of the technology inside is that the
company's R&D cost is minimal since it is the component manufacturers
in the industry that foot the bill to advance the technology, not the "box"
makers. Although Dell does have to design the PCs, servers, and workstations
it manufactures, it does not have to pay for the design of any of the components
and is really limited in some ways by the components it can get off the
Another major misconception about Dell is that it consumes a lot of cash
as a part of its operations. Although many people mistaken believe that Dell
is capital-intensive, looking at the company's capital expenditures relative
to the earnings before interest, taxes, depreciation and amortization (EBITDA)
you get a much different picture. Dell only spends 10.7% of its EBITDA on
capital expenditures, compared to 30% for Intel Corp. and 21% for Coca-Cola.
Because Dell uses so little capital in its business, it can generate a
on capital in the 167% range and use excess cash to buy back shares.
These share repurchases help to maximize shareholder value by using excess
cash the company does not need to decrease the number of shares outstanding,
increasing the earnings per share by the same proportional amount.
Dell's ability to generate cash and repurchase shares is amplified by the
fact that it uses very little working capital to operate. For instance, Dell's
inventory turns in the quarter were the annualized equivalent of 33 times,
meaning that Dell kept approximately 11 days of inventory at any one time.
At another manufacturer, money might have been tied up in keeping more days
of inventory, meaning that money could not go to buy back shares. And buying
back shares is something Dell knows how to do quite well. Dell Computer
repurchased 5.7 million shares of stock during the quarter, bringing the
total shares repurchased over the last 18 months to 59.3 million. Dell has
outstanding "put" contracts to purchase another 27 million shares over the
next few months, indicating that the systematic share repurchases should
continue over the next three to four quarters if the company keeps up at
its current rate. Dell should only have 340 to 345 million shares outstanding
at the end of fiscal 1999 at the current rate of repurchase, down from the
362 million the company will probably end the year with.
To cap off the PC day, Dell competitor COMPAQ COMPUTER (NYSE: CPQ)
had some positive news of its own. While Dell was growing more than three
times faster than the market, slightly slower growing Compaq was meeting
some very ambitious goals in the lucrative workstation market. Compaq stated
that it was "on track" to sell 100,000 workstations in the first 15 months
after its entry into the market -- workstations being sold at the expense
of established, less efficient manufacturers like Hewlett-Packard, IBM, and
Silicon Graphics. Compaq came out of nowhere to take the top market share
spot in the U.K., intimating that this should be good for both Compaq and
Dell Computer, which entered the workstation market this quarter. Overall,
personal computer companies appear to have exceeded all but the most unreasonable
expectations for growth.
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