The Street continues to mistakenly believe that Dell
Let's do some back-of-the-envelope math to see why. (Not the most precise form of analysis, but the conclusion is robust. Do a Web search for "Longterm Capital Management" to see what happens when you value the opposite attributes.)
Dell now has $8.2 billion in net cash and investments and a market cap of $22 billion. That means the market is only valuing the actual business -- the enterprise value -- at $13.8 billion.
And how is that business doing?
Quite fine, thanks for asking. Dell has posted $4.1 billion to $5.2 billion in free cash flow (what I call "cash earnings") for every trailing-12-month period since Q1 2011. I think it's likely it'll do something in that vicinity for the next 12 months.
That means you can buy the business at around 2.75 times cash earnings (a real P/E of 2.75). So in less than three years you'll own a T-bill with a free Dell call option attached to it. But then again, what's done with that cash plays a key role.
Doesn't the PC business stink?
The PC business stinks, but Dell isn't a PC company anymore.
Just ask Dell's largest outside owner (at 7.5%), Southeastern Asset Management, manager of the Longleaf Partner family of funds. According to Longleaf's Staley Cates, who I heard live this month at the fund family's annual meeting: "We couldn't give a rip about [PC sales] because they're running off bad revenue and building good revenue."
Cates is referring to the fact that Dell is rapidly becoming the go-to IT provider for small and medium businesses (SMBs); an IBM
In fact PC-free "enterprise services and solutions" (i.e., IT) now accounts for 31% of the revenue and a whopping 50% of the gross margin.
That means Dell is doing approximately $20 billion a year in non-PC related revenue, revenue that Apple's wundertablets will only enhance as they put greater demands on servers. So Apple is actually Dell's ally, not its enemy, as the Street supposes.
What I think Dell is really worth
If we assume an IBM-like free cash flow margin of 15% on that $20 billion in IT revenue, we get about $3 billion in free cash flow from the non-PC part of the business. This makes intuitive sense since Dell's free cash margin as a whole is about 5%-9% and we know the PC side must weigh that down considerably.
So assuming $3 billion a year in IT solution free cash flow, the stock is trading at around seven times cash earnings with the net cash and PC business valued at nothing. Take into account the net cash, and essentially you're getting the IT business for about 4.5 times cash earnings with the PC business still valued at nothing.
To put that in prospective, Big Blue's enterprise value trades for around 16 times cash earnings, and Warren Buffett still thinks it's a good investment for Berkshire Hathaway at that multiple.
Putting a 16 multiple on Dell's IT $3 billion would value the enterprise at $48 billion or $27.06 per share. Add back the excess net cash and it's worth $56.2 billion, or $31.68 per share with the PC business valued at nothing.
Yes, $31.68 is just a rough estimate. But the stock trades at $12.50 and I'm assuming the PC business is worth (you guessed it) nothing, so the margin of safety here is huge. It reminds me of how Altria (formerly known as Philip Morris) was undervalued back during the 1990s because the market assigned Kraft, among other divisions, no value at all.
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As mom said, all good things happen to those who wait.
