Boring Portfolio

Dell Relativists Sell Pell-Mell

By Dale Wettlaufer (

ALEXANDRIA, VA (Feb. 17, 1999) -- With a rebel yell, they cried "Sell, Sell Dell." In the midnight hour, they cried "sell, sell sell. Sell Sell Sell!" The Boring Port took a knock today from "tech stocks," as the world fretted over Dell Computer (Nasdaq: DELL) through relativist eyes. Relativist eyes would see a big problem for Dell when its fourth quarter year-over-year revenue growth was 38% and its return on invested capital performance this quarter was 170% (annualized). Both of these were lower than the company has recently reported. Net cash flow from operations was $752 million while capital expenditures for this company are relatively light. Remember, this is a cash flow industry, it's not an asset-intensive industry. People who focus on the company's price to book are missing the boat. It's precisely because the company's return on equity is so high that its price/book is so large.

Many commentators want to read a tectonic shift into the sequential numbers. As I heard from distributors last week and matched that with Compaq's (NYSE: CPQ) recent quarterly performance, I knew the pricing environment would be tough in some segments. Dell avoided some of that in desktops as third tier distributors pushed other OEMs' product out of the channel. Just to let you know what I'm saying here, that is my individual reading of the situation. In the high end, though, it appears that Compaq was aggressive, and Dell chose to go the route of pricing discipline there, as they said last night on the conference call. I wouldn't be surprised if Hewlett-Packard (NYSE: HWP) was pricing servers aggressively, either.

I would rather not spend too much time discussing what I think of the short-term focus of certain other media outlets, investors, or traders on Dell's fourth quarter. What I did want to mention is that Goldman Sachs PC analyst Rick Schutte said last week that he thinks Dell might turn up the heat in the consumer sector. As owners of Gateway (NYSE: GTW), that's not something we want to hear. But we have heard it and we have to deal with it. Hearing that Dell wants to open stores like Gateway Country validates our appreciation of what Gateway has done here, but it's also a bummer to hear that someone else is jumping into that space so quickly. I calculated the company has 149 stores open from the store locator on their website, which means the company has invested something over $100 million in the stores. The cash-on-cash return on these stores is 100% in the first year, which is absolutely phenomenal. That Dell is attracted to these economics is not surprising.

Does this mean it's the end of the line for Gateway here? No. When you look at the PC industry, a salient feature of the current PC environment that is often missed is that the top tier and direct OEMs are taking share from lesser OEMs and white box makers. So the fact that Compaq did well and Dell did slightly less revenues than the market assumed is not an issue as far as growth headroom goes for Dell, Gateway, Micron Electronics (Nasdaq: MUEI), or IBM (NYSE: IBM). If HP wants to get aggressive on pricing in servers, that's not going to immediately effect our opinion of the PC industry, but any pricing irrationality makes me nervous. The PC industry is not a relax-and-collect-the-profits sort of business. It's hard work to get ahead. That's why I am impressed with what Gateway is doing and I expect it to continue with its performance, but that's within the context of knowing this is a very difficult business to be in.

Cisco Systems (Nasdaq: CSCO) fell today, which is a wonder, really. Cheaper PCs and a 76% year-over-year growth rate in enterprise systems at Dell (including servers, workstations, and storage) are great signs for the growth of the Internet. I've been working for a number of days (when I have the time) to get the Cisco call finished. That John Chambers sure does give a comprehensive overview. I've posted four pages of his and Cisco's CFO's commentary on the Boring board. Click here to check it out, remembering that I'm still not done with it.

When you read this, you'll understand why we as value investors continue to hold such a large percentage of the portfolio in this company. Cisco is extending its lock-down characteristics in data communications equipment and driving that into the wireless communications and voice markets. Take a look at the market caps of fiber-based long distance companies Qwest (Nasdaq: QWST) and Level Three (Nasdaq: LVLT). If the market is at all efficient (and I believe it is, but not so much in the modern portfolio theory sense of the term), large amounts of cash flows from IP-based voice traffic are being discounted in the prices of these companies. Cisco's routers, switches, and other infrastructure-enabling products will be a vital part of these networks. I paid close attention to what Cisco CEO John Chambers had to say about these developments.

By the way, here's a great link to an interview with the Chief of Level Three Communications, James Crowe. You'll remember him as the founder of MFS Communications, which was sold to UUNet, which was subsequently acquired by WorldCom, which subsequently became MCI WorldCom (Nasdaq: WCOM).

Finally, on volatility, we will experience it on the downside and the upside once in a while. Short-term quotational losses and gains are neither sources of high anxiety or exhalation for Alex and me. We're not position traders and we don't measure our success or failure over three month increments of time. We are aware of how we're doing relative to the market, but we're not going to change the way we think about things based on very short-term performance results. Smoothing out volatility by increasing the amount of holdings in the portfolio doesn't interest us, really. The number of positions in our portfolio will be a function of the number of great companies we can find to invest in. Since we don't have investors that have a liquidity or volatility preference, the composition of our portfolio represents what we're comfortable with and what we think is the most rational way to go about things.

Finally, here's a great link from the Berkshire board on AOL. Foolish dentist Doug has some excellent observations on "time diversification," which I think is a very insightful counter to the traditional diversification metrics of beta.

We hope to see you on the Boring message board sometime soon.

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02/17/99 Close
Stock  Change    Bid
BRKb  -16      2371.00
CSL   -1 5/16  42.25
CSCO  -3 15/16 95.13
GTW   -2 7/8   67.00
                   Day    Month   Year  History
        BORING   -2.44%  -5.12%  -6.69%  25.30%
        S&P:     -1.43%  -4.34%  -0.10% 104.26%
        NASDAQ:  -2.81% -10.25%   2.56% 116.04%

    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96     95.13   297.09%
  8/13/96  200 Carlisle C    26.32     42.25    60.49%
 12/31/98    8 Berkshire   2244.00   2371.00     5.66%
   2/9/99  100 Gateway 20    72.38     67.00    -7.43%

    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  21403.13 $16013.14
  8/13/96  200 Carlisle C  5264.99   8450.00  $3185.01
 12/31/98    8 Berkshire  17952.00  18968.00  $1016.00
   2/9/99  100 Gateway 20  7237.50   6700.00  -$537.50

                             CASH   $7127.20
                            TOTAL  $62648.33