Dell Is Selling TVs…So Is It A Buy Now?
Dell Inc. reported fiscal
first quarter 2005, results last Thursday, May 12.
I thought the results were pretty strong, considering aggregate corporate IT
spending in the U.S. hasn’t increased significantly: Dell continues to increase
share of a relatively static pie.
Revenue was “at” company guidance, at $13.4 billion; the U.S. component of its
business was slower (up 14 percent); the international component stronger than
expected (up 21 percent). Europe in particular delivered market share gains. By
customer segment, the enterprise business was weaker than the consumer business,
possibly accounted for by product sales mix. On a sector-by-sector basis,
storage was up 49 percent, services (which includes servers) was up 30 percent,
software and peripherals (S&P) rose 29 percent to become the largest non-desktop
contributor to total revenues.
Dell’s gross product margin was 18.6 percent, the highest it’s been since 2001,
driven by a richer product sales mix and lower component costs (including DRAM
memory, discussed extensively in this column over the last few months —
March 21 and
February 11 ). Operating margins were up for both the U.S. enterprise
and US consumer business: at 9.4 percent and 7.5 percent respectively, up
sequentially from 9.0 percent and 5.0 percent. Despite the improvement in
margins, this was offset by higher operating expenses, which increased 6 percent
faster than Dell’s underlying revenue growth rate. A trend to keep an eye on
going forward; and which will hopefully be reversed.
The outlook for Dell is positive: although PC growth is slowing, Dell continues
to increase its share of the business due to weakness at its competition:
distractions at IBM / Lenovo following the merger, and Hewlett-Packard’s
continuing weak execution. (Has HP executed well since the Compaq merger over
three years ago? I don’t think so.) For next (second) quarter, Dell is expecting
modest sequential revenue growth, with sales in the range of $13.6 to $13.8
billion and EPS in the range of $0.37 to $0.39.
Having rocketed to number one computer maker in the U.S., from a standing start
in 1985, Dell is now transforming from a computer vendor to a diversified IT
vendor. In particular, brief mention was made on the conference call (and at
Analyst Day, on April 7) of Dell’s foray into manufacturing televisions; I
understand the company has plans to expand into other consumer electronics for
the “digital living room” although few specifics have been provided.
Dell started selling flat screen TVs in late 2003, now selling them in modest (4
to 5 digit) quantities. The company is making smaller (less than 42″) LCD and
larger plasma displays. Some expect Dell to have between 5 percent and 10
percent of the flat screen TV market in five years time. Pretty aggressive. But
players are always coming and going in consumer electronics; and in TVs in
particular — remember Zenith? Westinghouse? Magnavox? His Master’s Voice (aka
HMV)? Since new players are always ascending and older ones declining, in CE
Dell has a real shot at displacing some of the weaker TV players’ share.
Dell is great at selling electronics: the company rocketed to number one share
in computers in the US not by coming up with new designs but by utilizing
superior supply chain and logistics management techniques. It took the direct
sales model and elevated it to an art: selling computers on demand via
telephone, the Internet, and catalogues. Dell products may not be the most
innovative, but its inventory and delivery times show its ability to reap the
most rewards from manufacturing and logistics technologies.
Dell manages inventory and logistics better than any other computer
manufacturer, and this is the source of its competitive advantage. Consequently,
Dell delivers lower-cost, quality PCs to people faster than the competition,
while maintaining higher profit margins. It plans to do the same with consumer
electronics — starting with TVs, whose operating margins — at around 10
percent — are higher than the industry average for PCs, which run at around 2
to 3 percent. Dell’s operating margins on PCs are higher than average, owing to
its distribution model; but TVs they are, nonetheless, declining. And margins on
TVs are higher still.
Even though Dell has been fantastically successful, it needs a new growth
engines. Although Dell continues to grow market share in PCs, notebooks,
storage, and enterprise servers — outpacing computer industry growth rates —
overall PC growth is slowing from the 20 to 25 percent levels of the late ’90s
to around 9 to 10 percent widely expected in 2005. In addition, PC prices and
profit margins continue to fall. Increased competition, coupled with very low
labor costs enjoyed by Asian manufacturers (particularly in China and Taiwan),
is making computers so inexpensive that it’s getting more difficult for
companies Dell to make money from computers alone.
Bear in mind Dell plans to grow from its current $49 billion in annual revenues
to someday meet the ambitious new $80 billion revenue target announced by CEO
Kevin Rollins at its April analyst meeting (no time period assigned). The total
global IT market stands at around $1.2 trillion; Dell currently has around 18
percent of global market share. But as it becomes more diversified, it’s
possible that 60 percent to 65 percent of Dell’s future $80 billion revenue
could be derived from non-PC products — including TVs, displays, media center
PCs, and many others. Aggregate revenue growth in these categories is twice that
in desktop computers; they also have much higher profit margins.
Consumer electronics is a fertile market. In particular, digital television
sales were a front-runner in 2004. The Consumer Electronics Association reported
DTV sales in the U.S. reached $10.7 billion on 7.3 million units — an increase
of 78 percent in dollar sales and 63 percent in unit sales over 2003. One of the
biggest drivers of DTV is flat-panel, ultra-thin displays; total sales of LCD
TVs, one of the fastest-growing segments in consumer electronics, exceeded $2
billion in 2004 and are expected to surpass $3 billion in 2005.
This is why Dell is now selling TVs: Consumers spend heavily on entertainment.
Dell started making flat-screen TVs in late 2003, going head-to-head with
established Asian heavyweights Sony Corp., Sharp Inc., Toshiba Corp., Panasonic
(the TV division of Matsushita Electric Industrial Co.), Samsung Electronics Co.
and others in the traditional consumer electronics markets. Dell will be an
important competitor to Panasonic and other CE companies in flat-screen TVs.
Dell executes superbly in PCs and has a great shot at executing well in TVs.
It’s not about the technology; it’s because we are seeing a change in the
business model. The tech is the same for all players, and each will use its own
expertise to gain an advantage. But Dell’s big differentiating factor is the way
is manages its business: built to order and direct to customers. Dell can
collect revenue before it ships the product.
Judging by the display booths at CES in January in Las Vegas, Dell will have
plenty of company. The proliferation of
monitors and displays was discussed in this column on
January 3. Improved
manufacturing processes and increased LCD production (outlined
in
last week’s column)
will result in a huge drop-off in prices; this is great news for consumers.
According to Electronic Engineering Times, the cost could be below $1,000 for a
42″ LCD panel by the end of 2005. This is not great news for Dell’s long-term
profit margins, however. Although operating margins on TVs are currently more
attractive than the industry average for PCs, long-term profits are no more
sustainable for TVs than any other piece of consumer electronics.
But so what if long-term TV margins will decline? Securing share of the TV
business, which has higher margins than computers, is a good move; even if Dell
gets 5 to 10 years and a margin boost out of riding the TV wave, that’s better
than where its at now: market share leader in a lower-margin business.
More importantly, a Dell TV would be a beachhead in our living rooms, a base
from which the company could sell higher-profit add-ons such as home servers,
audio, and speakers. Media center PCs and boxes are two of those products; they
resemble garden-variety PCs but are all-in-one PC and entertainment systems with
the ability to play music, edit photos, and play and record video — together
with all the applications needed for surfing the Web. HP is the leader in this
emerging market with its HP-z500 Windows XP media center-based PC; a box that
can manage photos and music, display and record video, and access the Web. Apple
Computer has its Macintosh Mini for managing music and videos. But Dell is not
far behind.
Dell does have an institutional hurdle to overcome: It does not presently own
enough retail shelf space in which to display its TVs. Customers are accustomed
to comparing TVs side-by-side prior to a purchase. This may not limit Dell so
much in smaller LCD screens; but it will limit it in large, more expensive
plasma displays. Dell will offer a significant price advantage, believing buyers
will trade off the above risk for a much lower cost.
Furthermore, Gateway Computer, one of Dell’s strongest PC-making competitors,
recently exited the TV business as a dismal failure. But bear in mind Gateway
wasn’t that great at execution in the PC business; and failed in TVs. So,
there’s a good chance that Dell, which is superb at execution, will succeed in
the consumer electronics businesses. And, as a result, it will find that the
power of its brand in computers is extensible into TVs and other consumer
electronics.
But for now, Dell’s revenues are almost entirely from computer-related products
and accessories. And I continue to believe Dell will remain the strongest player
in computing.
So, for
all the sunshine I’m pouring onto paper about what a good strategic move this is
for Dell — and a necessary move, at that — will this lift the DELL stock
price? While I think Dell is going to kick @ss in TVs, I wouldn’t be using this
as a sole catalyst for now: A good strategic move isn’t necessarily a near-term,
positive catalyst. Initial TV unit volumes are too small to impact either
revenue growth or gross margins. Of course, by the time TV unit volumes are high
enough, product margins will have come down! But, if unit sales the next couple
of years indicate that Dell can, in fact, do for TVs what it did for PCs —
i.e., get people to buy them largely without seeing them — I’d feel more
positive about this move as a small catalyst.
I’d stay
on the sidelines until I saw early signs of high single digit growth in IT
spending and of a large-scale upgrade in enterprise technology. That’s what is
needed to move DELL meaningfully higher: increasing share of a growing,
higher-margin enterprise market, rather than increasing share of a relatively
static market. But if I were someone with a 5-year horizon, I’d probably own a
small position; in part because DELL is a good safe haven stock with less
downside that most other names in the tech space.
DELL looks like it might have limited upside. I could maybe see $40 at some
point. However, if it reversed this optimistic move and closed under $38 ,then
it would likely just go back down into its range of $36 to $40: Stuck in this
range and not going anywhere
in a hurry.
Melanie
Hollands
melanieholllands@yahoo.com
