Dell Technologies looking to serve AI-optimized offerings
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Dell Technologies (NYSE:Dell), another technology company that is looking to get on the AI bandwagon, has seen a significant run up in its stock price this year. Dell has seen its stock price rise from about $74 on January 2 to about $133 on November 5, a more than 70% uptick. The inclusion, or re-inclusion, of the Round Rock, Texas-based company to the S&P 500 index this year has also aided its prospects. The company, famously started by CEO Michael Dell in 1984 when he was a student at the University of Texas, Austin, has come a long way since he first took it public in 1988 as Dell Computer Corporation.
Dell is now in its second innings as an S&P 500 company, having been on the index in its previous life as a public company, before it went private in 2013. The move to go private came about as the company’s core personal computer business was challenged as sales started dropping. CEO Dell then decided to revamp the company for the long run to take advantage of growing corporate opportunities such as cloud computing, networking and storage and he wanted to do this without having to dance to the tune of the public stock market.
Back to the public stock market
The $24.4 billion leveraged buyout of shareholders in 2013 to take the company private was accomplished with cash and equity input from CEO Dell, financing from private equity investor Silver Lake and MSD Capital (a private investment firm that Dell started in 1998 to manage his family investments), and a $2 billion loan from Microsoft. Additional debt funding was also tapped for the buyout. As a private company, Dell also bought up EMC in a leveraged-buyout for $67 billion in 2016, a deal touted as one of the largest technology industry acquisitions ever.
The EMC purchase also gave Dell an 82% stake in VMWare, a virtualization software company (the remaining18% stake in VMWare was publicly traded). To finance the EMC buyout, Dell had also engaged in financial engineering with the creation of VMWare tracking stock that tracked the performance of Dell’s 82% stake in the company. This publicly traded stock served as collateral for some of the debt raised by Dell to buy up EMC.
After having accomplished the goal of better preparing the company to take advantage of new corporate opportunities, Michael Dell then brought it back into the public stock markets in 2018. To simplify its structure, Dell paid off the shareholders of the VMWare tracking stock at that time, effectively retiring the tracking stock. And in 2021, Dell spun off its 81% equity stake in VMWare (Broadcom acquired VMWare in 2023). All this financial maneuvering has also left Dell in a negative equity position. The company is now looking to AI as a source of growth. Should you invest in Dell based on this prospect?
Serving up good second quarter results
For the second quarter of its fiscal 2025 year, ended August 2, 2024, Dell reported $25 billion in revenue, up 9% over the year. Its infrastructure solutions group (ISG) (which sells corporate offerings such as storage solutions, servers, networking solutions and software virtualization solutions) saw revenues rise 38% to $11.6 billion, with revenues from servers and networking gaining 80%.
However, its client solutions group (CSG), which offers branded personal computers and peripherals (such as keyboards, mice and docking stations) and computer services, as well as third-party software and peripherals, saw its revenue dip 4% over the year to $12.4 billion. The company reported earnings per share of $1.17 for the period, up 86%.
In the company’s second quarter earnings call with analysts, Yvonne McGill, Dell’s chief financial officer, attributed the revenue decline in Dell’s client solutions group to a 22% decline in consumer revenue (while its commercial revenue remained flat at $10.6 billion). According to her, “CSG operating income was $767 million, or 6.2% of revenue, due to a more competitive pricing environment. We expect growth in the second half of the year, particularly in the fourth quarter. The coming PC refresh cycle and the longer-term impacts of AI will create tailwinds for the PC market.”
McGill expects Dell’s revenue for its fiscal 2025 year to be in the range of $95.5 billion to $98.5 billion, making for 10% growth, as the company continues to grow in the second half of the year. This would make for non-GAAP earnings per share (after making adjustments to reported earnings based on accounting principles) of about $7.80. For the third quarter, she is looking to a revenue range of $24 billion to $25 billion.
According to Jeffrey Clark, Dell’s chief operating officer, “Our AI momentum accelerated in Q2 and our results and outlook demonstrate that we are uniquely positioned to help customers leverage the benefits of artificial intelligence.” Orders for AI servers and shipments increased in the second quarter, he said, pointing to Dell’s “unique capability to deliver leading edge air and liquid cooled AI servers, networking and storage, tuned and optimized for maximum performance at the node and rack level, combined with leading ecosystem partners and world class services and support.”
While he sees a rise in business customers going for AI solutions every quarter, businesses are still in the early stages of AI adoption and present more opportunity, along with the potential for governments to adopt AI. The company shipped $3.1 billion worth of AI servers during the second quarter and has a backlog of $3.8 billion of orders.
Besides AI servers, he also sees more demand for regular servers as workloads are getting off the cloud. “They’re repatriating and as they repatriate, they’ve got to go somewhere. And they’re coming back on-prem on servers and storage.” Besides, these servers have to be replaced as they age.
Looking to AI opportunities
According to Clark, “We are leveraging our strengths to extend our leadership positions and lean into new opportunities like AI. We are offering customers choice, flexibility and control of how and where they build, train and run artificial intelligence. We are still in the early innings, and our AI opportunity with tier 2 CSPs (cloud service providers), enterprise, and emerging sovereign customers is immense. Our view is supported by an AI hardware and services total addressable market of $174 billion, up from $152 billion, growing at a 22% compound annual growth rate over the next few years. We are competing in all of the big AI deals and are winning significant deployments at scale.”
Dell has improved the margins on its AI offerings, he said, thanks to the “engineering value add” and the “technical value add” that the company offers customers, as well as its expansion from “beyond the specific node to the rack level deployment.” Besides the demand from customers focused on training AI, Dell is also seeing demand from other enterprises looking to deploy AI in life sciences, healthcare, higher education, financial services and other industries.
The company is also looking to benefit from AI by integrating it into its own operations. According to CFO McGill, “We’re using it to improve customer and team member experiences in sales, software development, services, content management, and our supply chain. And in turn, we’re using our experiences to help our customers realize the benefits of AI for themselves.”
CEO Dell has observed that he sees a great potential for AI to transform businesses, and the world. In a conversation with management consulting company McKinsey, he said, “The ability to reason using all the knowledge in the world on any given subject and more accurately distill that into outcomes and new understandings will accelerate and advance scientific discovery. It will make humans happier, healthier, and more successful. It will improve everything we humans try to accomplish.”
A commoditized market
While Dell is looking to focus on the opportunities it sees, the road ahead can also be slippery. For one, the company operates in a very competitive marketplace for what tend to be commodity products, such as the personal computers and monitors that account for more than 50% of its business. HP and Lenovo are competitors in this space. Servers and storage racks are also difficult to differentiate. Also, while Dell’s AI server business is growing, it is still a minor part of its sales and it is difficult to pass on the high costs of graphics-processing units (GPUs) that go into servers to enterprise customers. Dell’s market is also susceptible to economic downturns.
According to Dell COO Clark, on the company’s earnings call, the aspects that differentiate Dell from the competition and give it pricing power include “the broadest coverage model in technology, a combination of our direct sales force and our partner programs.” Dell will continue to invest in and broaden its channel programs to cover more customers. He also sees a supply chain that’s not matched in the industry. Dell continues to invest in that as well as in research and development. He also pointed to Dell’s market leadership in a number of product areas, such as commercial PCs, displays, workstations, data protection, storage and traditional servers. Another differentiating aspect for Dell is that it services its own products, a strategy it is also extending to the AI market.
Another risk to note is that Dell, which operates internationally, uses derivatives to offset its foreign currency exposure and also interest rate risk on its debt. Dell could also be negatively impacted by any tariffs a potential Trump Administration might enact, considering that it sources a lot of components from overseas markets and also and also outsources a good part of its production to overseas contractors. For some inputs, Dell deals with only one supplier or has limited sources of supply, which could cause delays in the availability of its products to its customers.
Dell is also watching on the outcome of the Organization for Economic Cooperation and Development’s tax proposals, including one to put in a global minimum tax, which could increase the company’s tax outlay.
Another issue is that CEO Dell has a controlling voting position in the company, and together with his affiliates controls more than 90% of Dell’s common stock voting power, giving him effective control over the company’s voting outcomes.
Heavy use of leverage
Dell’s current ratio of 0.72 at the end of the second quarter indicates that its current assets don’t adequately cover its current liabilities, which doesn’t give it a good liquidity position. Dell’s heavy use of leverage in its saga of leaving and re-entering the public market has left it with a big debt load of about $25 billion, and a shareholder equity deficit of about $2.8 billion. The company’s debt compared to earnings before interest, tax, depreciation and amortization (EBITDA) was at 1.4 times for the second quarter, as it continued to pay off debt and raise its earnings.
Its gross profit margin was at about 22% for the second quarter. And its earnings per share for the last year of $5.58 make for a price-to-earnings ratio of about 24, compared to a hardware industry average of about 34. On a forward basis, Dell’s P/E ratio looks more favorable at 16.5. On a positive note, Dell raised its quarterly dividend 20% this year to $0.445 per share and also engages in share repurchases.
At the end of the day, investing in Dell is a bet on Michael Dell’s notable entrepreneurial acumen. Once the company pays off its big debt load and if it is able to seize the emerging opportunity in AI, an investment in Dell could pay off for shareholders.
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Note: I do not own any individual Dell Technologies stock and I do not intend to take a position in the stock within five days of publication of this post. This write up is my unbiased opinion and not intended as financial advice. All investments carry risks and you should talk to a financial advisor to learn about the suitability of an investment for your portfolio. I did not receive any compensation for this piece that influenced my views.