Wednesday, March 18, 1998

Cash-King Portfolio Report
by Rob Landley

Austin, TX (Mar. 18, 1998) -- Yesterday, Al wrote that he'd decided that Dell Computer (Nasdaq: DELL) isn't a Cash King because the business isn't light enough. In the spirit of modest, congenial, even-handed debate -- the sort that we cherish here in CashKing-dom -- I'd like to outline, in today's report, why he's totally, totally wrong... completely off his rocker... and almost not deserving of our attention!

Now that I have your attention, and Al's, I'll aim for truth and congeniality through the remainder of this report. But I'll just be aiming... probably often missing! So, look out!

Ok, I'd like to persuade Al from his position. First, we need to precisely pinpoint his argument against Dell as a CK. It all boils down to one thing. Al believes that despite all the many wonderful things about Dell's business, its gross margins aren't high enough today (and may never be) to qualify it for our portfolio. End of story. Nada mas. He doesn't like the idea of making a long-term investment in a business with 22% gross margins.

To that I say: Patooey! (Picture a piece of licorice flying over Al's head right now. How's that for congeniality?)

Let's begin at the beginning. Your four managers/writers here all agree that no single CK criterion can make or break a business. Not driving too high the levels of long-term debt. Not falling short of our beloved global consumer brand name. Not punching in above the mystic Flow Ratio of 1.25 that we've all talked so much about in the message folder. And not, as well, gross margins sitting below 50%.

For a few examples, we need look no further than a click away here in the Cash-King Portfolio. 1) Neither Microsoft nor Intel has proper repeat-purchase business models. 2) Coke is banging hard against market saturation, with consumer demand, in the form of annual revenue growth, slackening. 3) Pfizer has high accounts receivable and little consumer-brand recognition. 4) And the Fool's stated goal is, basically, to put companies like T. Rowe Price out of business -- it is a financial services business with a healthy serving of underperforming mutual funds.

Yet all five of these stocks are in the Cash-King portfolio. Ladies and gentleman (and you too, Al), no company is perfect. There's SOMETHING wrong with all of them. The horrible beauty of the Cash-King approach is that its demands cannot be met. No perfect business model exists. But, pretty early in life I hope that all of us learned that you don't have to be perfect to be good. Or stellar. Or excellent. And you certainly don't even have to be NEAR perfect to be the best in a consumer-franchise industry.

Ok, so we've rightly reduced Al's argument down to the 22% gross margins, and we've reminded Al that no single criterion is almighty. If the company walks like a Cash-King, roars at its competitors like the Lion King, dresses in purple gowns, and has a big treasure chest in the attic, it may just be a Cash-King even if it has a single blemish on its cheek.

Let's press on by a) referring to ourselves in the journalistic plural, despite the fact that there's only one person writing this article, and b) actually address Al's concerns head on.

Dell sells technology and a lot of it. Real big, bulky stuff that has to be stored, boxed, and shipped. Stuff that is expensive to make. Stuff that's merely a commodity when sold. Stuff that shouldn't earn its builder high profit margins. That's the business that Dell is in, and it's not, generally, the modus operandi (Latin for "modus operandi") of a Cash King.

So why hasn't this hurt Dell yet, and why do I think it isn't GOING to hurt Dell anytime soon?

First of all, Dell mitigates this fact -- within an inch of its life -- by reducing inventory turnaround time to almost nil, zip, zero days... immediacy. If something's only in your possession long enough to carry it from one end of the assembly line to the other (at which point it gets dropped into a waiting UPS truck that takes it across the land), it doesn't matter how heavy the product is. You don't have to pay to store it, or watch it depreciate, or any of the other nasty things associated with carrying heavy inventory.

For proof of the effectiveness of this approach, the PC industry -- in fact, the entire technology industry -- is restructuring to copy Dell's approach to sales. You see, Dell is much better at just-in-time manufacturing than any of its competitors, by a long shot. They're all playing catch-up in this marathon. Meanwhile, Dell is busy working on its breathing, its stride, and its commitment -- busy bettering its sales performance.

Now, Fool, remember that the primary aim of a Cash King business is to turn product into cash and to speedily turn that cash into more cash. For Dell, inventory is but a momentary transition in this process. Dell's so darn good at turning over its inventory that it doesn't matter how bulky or perishable or costly it is. The stuff's not around long enough to notice.

And if that's not enough to settle this score, hey, most of the downside of having a "heavy" business is borne by Dell's suppliers, not by Dell. The expensive manufacturing plants needed to make hard-drives are Western Digital's problem. Or Seagate's. Or Quantum's. Or IBM's. Dell is quite happy to play them off each other in a battle for the least-expensive, best-quality components. The same goes for the following devices that are part of the average Dell personal computer: memory, CPUs, sound cards, monitors, mice, keyboards, CD-ROM drives, and almost all of the other components that Dell assembles into working computers.

You see... on the input side, Dell benefits handsomely from the commodity nature of its business. It loves the price wars in the components side of PC manufacturing. But on the output side, the company has enough of a brand name to charge a little extra from buyers for having that word "Dell" on the box. Further, if it undercuts its competition on price (which it can, because it has lower overhead costs due to high inventory turnover and the resulting economies of scale), that brand name translates into boosted sales and an opportunity to gallop into new markets, increasing its share of the business dramatically.

In fact, Dell is really more of a service company than a product company. Its service? Component integration, configuration, assembly, and testing. It also provides training, technical support, and some software development.

And service is an excellent thing for a Cash King to sell: You have to pay for it every single time you use it. And if Dell wants to expand, all it has to do is buy more space and train more people. The company doesn't need any fancy manufacturing equipment -- nope, just a bunch of people popping drives into bays, plugging cards & memory into motherboards, screwing on the cases, installing software, running a test suite to make sure everything works, and then throwing the whole mess into a box.

I'd also like to point out that Dell is one of the first businesses that is actually benefiting in a big way from this "Web commerce" thing we keep hearing so much about (eCommerce or netSales or DigiDelivery or whatever they're calling it at all those Internet conferences these days).

Like Cisco and, Dell actually sells its products directly through its website. It rings up millions of dollars in sales every single day, 24 hours a day, 7 days a week. And Internet distribution really brings its costs down, since it doesn't have to pay for a phone bank and the people to staff it around the clock. Increasing capacity in your ordering department is similarly trivial, just fire up a few extra servers. And by taking orders via email, it can follow up with customer service in the form of FAQs and email updates -- which reduces its exposure to pricey, cumbersome 1-800 customer service lines.

Now Al, I do agree that Dell can't keep up the pace of its current expansion forever. Eventually it's going to run out of competitors to steal market share from, at which point it will have to be content to grow at the same rate as the entire computer industry. But in that case: a) it'll be #1 in its industry, definitely a Cash-King plus; b) the 20% or so that the computer industry grows each year isn't bad, especially when you've got plenty of cash left over to spend on stock buybacks; c) as it grows, it can begin offering new, "lighter" technology products -- it is already pushing hard into higher-margin servers and, who knows, it may get into more software development someday; and d) if Dell doubles three more times before it runs out of competition, it will have proffered investors greater returns than we expect to get from Coke in the next decade.

To my eye, Dell is the best kind of Cash King -- one that's still in its "rapid growth" stage, with no market saturation concerns in sight. Its greatest challenge is getting supply up as fast as possible to meet the ferocious demand around the world. That's a nice challenge to face. And until that demand really slackens, I expect Dell to -- in the words of Bob Dylan -- "Keep on keepin' on, like a bird that flew." It may even outsoar our five present CK stocks over the next ten years. And, yep, its gross margins may even steadily improve from year to year.

Whether we choose to buy Dell Computer today, someday, or never, I do think the Cash-King slipper fits this Austin, Texas technologist. It'll be fun to watch. And after ejecting a piece of licorice over your head... let's hope I'm right!

Fools, I'll be in this spot all next week, but tomorrow Al will be back with Q's & A's from the message board. In the meantime, drop us a note about Dell in the Cash-King message folders. Whose argument do you find more believable?


Stock  Change    Bid 
 CHV   +1 9/16  83.63 
 KO    +2 3/8   74.81 
 EK    +1 1/8   62.06 
 XON   +1 3/4   64.63 
 GM    -  11/16 71.31 
 INTC  +  1/4   76.94 
 MSFT  +1 7/16  81.75 
 PFE   -1       88.25 
 TROW  -  5/16  70.75 
                  Day   Month    Year  History 
         C-K      +0.71%  -0.43%   1.32%   1.32% 
         S&P:     +0.47%   3.45%   8.41%   8.41% 
         NASDAQ:  +0.50%   1.00%   8.19%   8.19% 
     Rec'd    #  Security     In At       Now    Change 
    2/27/98   27 Coca-Cola     69.11     74.81     8.26% 
    2/3/98    22 Pfizer        82.30     88.25     7.23% 
    2/6/98    28 T. Rowe Pr    67.35     70.75     5.05% 
    2/3/98    24 Microsoft     78.27     81.75     4.45% 
    3/12/98   20 Exxon         64.34     64.63     0.45% 
    3/12/98   15 Chevron       83.34     83.63     0.34% 
    3/12/98   17 General Mo    72.41     71.31    -1.51% 
    3/12/98   20 Eastman Ko    63.15     62.06    -1.72% 
    2/13/98   22 Intel         84.67     76.94    -9.14% 
     Rec'd    #  Security     In At     Value    Change 
    2/27/98   27 Coca-Cola   1865.89   2019.94   $154.05 
    2/3/98    22 Pfizer      1810.58   1941.50   $130.92 
    2/6/98    28 T. Rowe Pr  1885.70   1981.00    $95.30 
    2/3/98    24 Microsoft   1878.45   1962.00    $83.55 
    3/12/98   20 Exxon       1286.70   1292.50     $5.80 
    3/12/98   15 Chevron     1250.14   1254.38     $4.23 
    3/12/98   17 General Mo  1230.89   1212.31   -$18.58 
    3/12/98   20 Eastman Ko  1262.95   1241.25   -$21.70 
    2/13/98   22 Intel       1862.83   1692.63  -$170.21 
                               CASH   $5666.26 
                              TOTAL  $20263.76 
 *The year for the S&P and Nasdaq will be as of 02/03/98