Nikhil Shamapant Ticker DELL Market Price The Business:

Dell Inc. Market NASDAQ Intrinsic Value $16.8 Country USA Margin of Safety

June 2012

At its core Dell is a computer seller. The 2011 10-K says Dell was founded on a simple concept: by selling computer systems directly to customers, we can best understand their needs and efficiently provide the most effective computing solutions to meet those needs. In fact, since Dells founding and even now, Dell is best known for its computing products. In 2011, Dells only addition to this business identity was that over time they had expanded their business model to include a broader variety of services and products as well as optimizing their supply chain and creating new distribution channels(retailers, resellers, and distributors) to sell their products. In 2012, Dells tune changed completely. Their General Business description in the 10-K Filing changed from 313 words in 2011 to 93 words in 2012. Why had their general business description become so simplified? It had broadened into a more general category. Rather than a company focused on selling computer systems, Dell has redefined itself as a global information technology company, and its product description was simply a focus on providing efficient and accessible technology solutions. Thats as general a term as you can get. Their Business Strategy description also shortened dramatically, as new language entered the 10-K. Cutting out a 3 component business strategy from 2011(efficient enterprise solutions, flexible value chain, strong balance sheet), the 2012 business strategy was solely focused on the transformation of Dells business. So What is Dells 2012 Identity? Dell is now an end to end technology solutions company. Essentially, they are focused on providing products in every area of tech, from hardware and computers to software and servers. The key emphasis now is on software and server product development. Acquisitions will be a big part of this expansion. So to conclude, Dell is now a two part company(to generalize a more complicated classification in the 2012 10-K). 1) Services/Software 2) Computers. Opinion? Services and Software are just as competitive an industry as the hardware, and Dells acquisition based position wont have anything close to a competitive edge. Given that, if they are smart with their acquisitions things may work. Services Revenue is gradually increasing as a % of sales and it has a 10% higher gross margin than the hardware business.

Nikhil Shamapant

Dell Inc.

June 2012

The Economics of the Business and the Competition: Dell is in a competitive industry, and the services/software industry it is transitioning into are also very competitive. Ultimately, Dell is in a commoditized industry, and competition is extremely difficult, as the barrier to entry is very low. The average economics of the business are evident in the financial statements, where real ROA is roughly 6%. Returns on Equity are heavily driven by Profit Margins and Leverage, although Dell has a strong balance sheet. Dell managements pessimism on the topic is clear as the description of competition in the 2012 and 2011 10-Ks are congruent except for the removal of This connection with our customers allows us to best meet customer needs and is one of our competitive advantages. Questions to Ask: 1. How is Dells Market Share? a. 2011 Estimates put Dells PC vendor shipment market share at about 12.1%, 0.1% higher than last year. HP is the leader in market share, but market share is declining. 2. What is the value of Dells Brand? a. From what I can see, not that great. Customer Service is negligible and the real brand to be looking at these days is Apple. One edge that Dell has over competition is its Cash Conversion Cycle. At -36 days, overall, Dell holds onto cash for 36 days before paying its suppliers. This means that Dell has amazing negotiating power with both suppliers and customers, implying that Dells products are somewhat necessary, and imply a certain negotiating position. Management: Management seems exemplary. Theyve revolutionized the supply chain(a somewhat older change, but it certainly is effective), and they continue to show efforts towards this as they promise to cut costs by $2B in the next 3 years from the supply chain. Management incentives are also based on long term value creation. Executive pay is based on peer groups(which are clearly laid out, company by company). Heres a telling quote from the Proxy: In evaluating the link between Mr. Dells pay and company performance, it is important to consider that Mr. Dell has not received an increase in base salary in over five years, declined a bonus for Fiscal 2008, 2009 and 2010, and declined equity grants from Fiscal 2005 through Fiscal 2010. Management is also intent on value creation. Theyve instituted share repurchases and are creating a new dividend which reflects Dells current position and rate of return.

Nikhil Shamapant Valuation:

Dell Inc.

June 2012

Relative Sum of Parts: Product Gross Profit(2yr avg): 9,075M Services Gross Profit(2yr avg): 3,528M Total Expense from Gross Profit to Net Income(2yr avg): 9,500M Weighted Avg Expense(by % gross profit): Product(74% of gross profit)= -7030 Services(26% of gross profit)= -2470 Product Net Income: 2,045M Comparable Multiple:HPQ-7.89, AAPL-14.8 Services Net Income: 1,058M Comparable Multiple: MSFT-11.2, IBM-14.6 Dells multiple should be higher than HPQs because HPQ has a management overhang that Dell does not, but lower than MSFT because MSFTs business has superior economics by a longshot. Product Multiple: 9, Services Multiple: 7. Multiple Choices are educated guesses, not exact science. Market Capitalization Price Target: 43 Billion. Relative Valuation per Share= $24 based on Sum of Parts. Peer: The closest comparable company is HPQ because it does both hardware and software, like Dell. However, unlike HPQ, Dell has unbelievable management and no management fears will overhang the price. P/E is still 8% lower than HPQs but it deserves to be at least 10% higher. P/E of 9 would imply a Relative Valuation per Share=~$15(assuming EPS of $1.66..EPS guidance for the year is likely to be reduced, in any case long term EPS should be roughly $1.66). Scenario1: Discount 10%, Growth 0%-All Perpetually. Assuming FCF this year of $2B(see above..thats conservative Relative Valuation will be heavily influenced by the outcome of Dells Acquisitions. Intrinsic Scenario1: Discount 10%, Growth 0%-All Perpetually. Assuming FCF this year of $2B(conservative). Intrinsic Value=$32.28B Scenario2: Discount 10%, Growth 0%(10 years), Growth -3%(Perpetually after). Assuming FCF this year of $2.5B. Intrinsic Value=$34.6B Scenario3: Discount 15%, Growth 3%(10 years), Growth -3%(perpetually). Assumes FCF of $3B. Intrinsic Value: $39.59B. Intrinsic Assumptions of Current Market Price: Discount=10% perpetually. Buying at $10 would imply a Market Cap of $17.5B. 1. Assuming FCF of 3B, this would imply 10 year FCF decline of -7% and perpetual FCF decline of -25%.

Nikhil Shamapant

Dell Inc.

June 2012

Catalysts: - New Dividend may create a price floor and a rush of Income investors - Management plans to cut costs by 2B over next three years by consolidating sales force and streamlining supply chain. Tangible changes that will increase EPS. - Share repurchases should boost EPS and dividends. - PC revenue level increase(management expects $47B from the end-user computing business alone by 2016 due to sales in emerging markets). o Take with a grain of salt, but to put into context, current PC revenue is $33B. Thats 9% revenue growth compounded annually. Risks: 1. Failure to complete the acquisition strategy a. May result in goodwill impairment b. May effect Dells Relative Valuation c. In general, if the company is growing by acquisitionswhat does that say about the core business? 2. Continuing Rough Economy a. So called temporary earnings issues in Q1 were due to issues with sales execution and a difficult economic environment. While sales execution seems easy to fix, it would also seem to be linked firmly with consumer demand, and a difficult economic environment is NOT an easy fix. 3. Microsoft Operating System is key to the business product lines a. http://www.thereformedbroker.com/2012/07/01/microsoft-tohardware-partners-now-this-is-happening/ Thesis: Ultimately, my thesis is that Dell is currently weighed down by fears of economic unrest and a now boring product line. While this has hit the stock, it has hit many peers as well, bringing down relative valuations. However, Dell dropped even further on a bad Q1 earnings report with weak revenue. With uncertainty on the value of Dells acquisitions, economic unrest, and short-term earnings, fear has enshrouded Dells stock price. The business is ultimately worth at least $15(5x expected future FCF) and worth $24 on a high range. I think buying at $9-$10 gives you a good 33% margin of safety. Expected Value, however, is a totally different concept. Here are my probabilities: 20%-Acquisitions dont work and goodwill impairment charges give the stock a fair value of $9(based solely on PC). 10%- Acquisitions work phenomenally, services revenue steadily increases while economic conditions recover and PC demand skyrockets back to the hotspot, giving the stock a fair value of $24. 70%Acquisitions work, but not amazingly well. No goodwill impairment but no serious revenue growth. Dell PC demand resumes and the stock is worth $18.

2. Assuming FCF of 2B, this would imply perpetual FCF decline of -5%.

Nikhil Shamapant

Dell Inc.

June 2012

Expected Intrinsic Value: $16.80