Value investors may hold chip giant Intel (INTC -6.41%) for their tech sector exposure. At first glance, that would seem to be smart move. After all, Intel has a dominant market share in PC and data center processors, and these end markets should benefit from work-from-home trends as well as cloud, AI, IoT, 5G and other next-gen tech applications. Meanwhile, the stock trades at just 9.4 times earnings and yields 2.75%.
However, Intel plunged over 10% after its recent earnings call last week, delivering results that showed falling margins in its data center group. Intel is currently under fire from rival Advanced Micro Devices, which has used Taiwan Semiconductor Manufacturing as its outside foundry to surpass Intel in producing 7nm processors. Intel has fallen behind in its own in-house manufacturing process, and management was tight-lipped as to whether Intel would eventually have to outsource its chips to TSM in order to catch up.
Basically, Intel is in a tough spot right now, and its turnaround, if it's coming, could take a while. However, for value investors interested in the technology space, the following three stocks look like better bets today, with more near-term catalysts.
Dell Technologies (DELL -1.66%) isn't just a cheap stock; it actually appears to be trading for nothing.
How is this possible? Dell, originally a server and PC maker, acquired tech giant EMC back in 2016. EMC held a number of stakes in various enterprise software companies, the most consequential of which was VMware, which "virtualizes" companies' IT infrastructure into a single plane of glass.
In fact, Dell owns roughly 80.4% of VMware, which is publicly traded. Currently, VMware has a market capitalization of $62.7 billion, meaning Dell's stake is worth $50.4 billion; however, Dell itself is only trading at a market capitalization of $50.9 billion. That means Dell's equity ex-VMware is only trading at a value of just $0.5 billion.
Last quarter alone, Dell's non-VMware business generated almost $1.7 billion in operating income. Yes, Dell has a hefty amount of debt on its balance sheet at roughly $54 billion, but given Dell's leading position in servers and PCs and its strong profitability this year, it's pretty unlikely the company is worth nothing.
In September 2021, a spinoff of Dell's stake in VMware to Dell shareholders would become tax-free, and CEO Michael Dell confirmed in July that the company is considering such a move. A spinoff would also necessitate the payment of a special dividend from VMware to Dell, which would help pay down Dell's large debt load.
If such a move did happen, Dell's shares could rapidly rise from the near-zero value it trades at today. Because the date of this catalyst could be within a year, it seems to be a better value story than Intel at the moment.
Speaking of VMware, its main rival in virtualization software, Nutanix (NTNX -1.79%), also looks like an intriguing value play. As more and more corporations turn to both multi-cloud and hybrid cloud solutions, the hyperconverged infrastructure (HCI) market is set to grow. HCI vendors like VMware and Nutanix allow corporations to manage different infrastructures through a simple interface, while also efficiently deploying IT assets.
IT research firm Gartner expects the HCI market to grow from just $4.4 billion in 2018 to $11.5 billion in 2023, good for a 21% average growth rate. Within that market, Nutanix has been consistently rated as the leading product in both Gartner and Forrester magic quadrant ratings. Customers are also giving Nutanix high marks, with a 96% overall retention rate, a 125% net expansion rate, and a very high net promoter score (NPS) score of 90.
What's interesting about Nutanix now is that it was late in its transition to a subscription-based model relative to other software companies. History has shown that when companies make the transition, it results in a near-term reduction in revenue, since customers pay annually instead of all at once for multiple years on a software package. However, it usually pays off in the future with more predictable growth, higher margins, and better customer satisfaction.
So while Nutanix only grew revenue 9% last quarter, its annual subscription revenue run-rate increased 29%. Meanwhile, subscriptions have gone from just 41% of revenue in the first quarter of 2019 to 87% of revenue today, meaning the transition is nearly complete. Since 2017, gross margin has increased from 63% to 81% today.
Meanwhile, the company received a shot of confidence in August after Bain Capital Private Equity invested $750 million in convertible notes in Nutanix. Those notes pay a coupon of 2.5% and are convertible into stock at $27.75 per share, above today's $25.32 stock price. Additionally, the PE firm will help the company search for a successor to founder and CEO Dheeraj Pandey, who recently announced his retirement.
Bain certainly doesn't make investments to make 2.5%, and given Nutanix's very reasonable valuation at just 3.7 times sales, I'd bet Bain sees much bigger dollar signs in Nutanix's future.
Finally, storage specialist Western Digital (WDC 2.77%) is looking like a good value stock today. The company has a new CEO in David Goeckeler, who took the job as of March 2020. Goeckeler has already made few notable moves, including suspending the company's dividend in May, then reorganizing the company into two distinct units around its hard disc drive business and its NAND flash business.
Some believe that could be a prelude to a sale of one of the units, which could unlock value. After all, Intel just sold its NAND flash business to SK Hynix for $9 billion, which would bring that market from six leading players down to five. In the second quarter, Western Digital made about $2.23 billion in NAND sales versus Intel's $1.65 billion. Therefore, just based on Intel's revenue relative to Western Digital, Western Digital's NAND business could fetch a valuation of $12 billion.
Meanwhile, Western Digital is only one of three HDD vendors, with about 36% market share in Q2. Rival Seagate is a pure-play on HDDs with 43% market share and an enterprise value of about $15.8 billion. While it's likely an imperfect comparison, based solely on its relative market share, Western Digital's HDD business could be worth $13.2 billion.
Adding both up would yield an enterprise value for Western Digital of $25.2 billion, versus its current enterprise value of around $19.6 billion, or about 30% upside. In addition, the consolidation of the NAND sector could make all of the other NAND players more valuable over time due to less competition, which could mean more upside for Western Digital's beaten-down shares.