Dell buys itself out at $13.65/share

Dell is buying itself out at $13.65/share. My quick summary is that for existing shareholders this is probably as good as it is going to get. Cash flows are going to decrease as the PC business continues to be eroded by tablets and mobile devices, and the company is going to be forced to face a very Hewlett-Packard type of situation where they’re going to have to get into serious competition against the likes of IBM – not inconsiderable amounts of risk involved.

Investors that really feel like a glutton for punishment in the PC space should consider an investment in Intel which would have correlation to the same marketplace. At a market cap of $105 billion there is zero chance of it going private but they are trading at a reasonable valuation and are not having their margins pressured nearly as badly as anybody in the PC space is.

Dell going private makes sense

There are heavy rumours that Dell is seeking to go private. The mechanism will likely be through a leveraged buy-out assisted with some other capital partners.

The necessary condition for this to occur is shareholder approval, and since Michael Dell still owns a substantial portion of the company (about 14% according to the last DEF14 filing) there would likely be enough sway to ensure that it happens.

Business-wise, it is probably better for the company because it can then make strategic decisions that would otherwise not be possible if they were a reporting entity. Dell’s core business is clearly stagnating and going private will probably be the way for the financing firms to figure out how to carve out the various businesses within Dell and try to recapture some value in the marketplace.

Looking at raw cash flows in relation to a $10/share valuation, one can see where this thought process would proceed forward, especially if you can float some ultra-cheap debt financing in a yield-hungry bond market.

The end of Microsoft

Anybody using Windows 8 should realize it is a disaster for Microsoft. Possibly even worse than Windows Vista. Just ask the question of whether you will be seeing corporate clients (the major money-makers for Microsoft) upgrading to the new operating system.

The whole corporate strategy of Microsoft after they crushed IBM’s competitor, OS/2, has been to put a ringed gate around all software users and make it as difficult as possible to port outside of Microsoft DOS/Windows as possible. This worked for the most part for about 20 years before mobile and internet platforms started to become prevalent and relevant. Now, Microsoft’s strategy is simply about salvaging what is left inside the ringed gate with their Office and Exchange Server suites, where they still have a decent amount of entrenchment.

A chart is fairly instructive in terms of what the market is sensing is the reception to the Windows 8 launch:

Realize that institutional investors have much more powerful access to various data (e.g. channel sales data) than the everyday joe retail investor and you can easily see they have been betting significantly against Windows 8 being a material impact on Microsoft’s bottom line.

In terms of valuation, while Microsoft is more attractive than purchasing long term government debt, all of the growth should be discounted from the company’s valuation and instead a financial salvaging model should be applied to the company’s equity – eventually their domination of the office and exchange server market is going to erode to the point where they will completely lose pricing power.

I am not even going to get into the topic of their totally failed mobile phone market strategy, which has been even more of a disaster than Windows 8.

It is also not surprising as well to see the associated corporations, Dell and Intel being equivalent hammered by the marketplace.

All three companies will survive, but they are going to be shadows of the titans they used to be. I will give a bit of an exception for Intel, whom seem to somewhat still have their competitive act still together.

The Dell and PC hardware value trap

I noticed recently that Dell (Nasdaq: DELL) slipped below $10/share. They’re now at $9.5/share or roughly a market capitalization of 16 billion (if you net out the cash and debt, the enterprise value is about $12 billion). This is on $3 billion income for the trailing 12 months, so something is completely out of whack – the market is either nuts, or they’re betting that Dell’s net income is going to drop significantly in the future. The latter is more likely to be the case.

I still don’t see anything worth investing in unless if you have a good sense of salvage or residual cash flow analysis. Dell is facing a compounding problem of being in a low margin industry that is not only shrinking, but is facing longer lifespan cycles and technological shifting.

In other words, they don’t have a proprietary tablet to be selling for ultra-large margins like some other fruity-named company.

Intel (Nasdaq: INTC) has an escape route – their processors can be used elsewhere and can command market pricing. They’ll take collateral damage, but will do relatively better. However, since the consumer end is still a significant portion of their market, I will also continue to lump them in the value trap category. Their anti-trust shield, AMD (NYSE: AMD), should also struggle. Considering that embedded chip makers such as ARM (Nasdaq: ARMH) are stronger competition to Intel, it makes you wonder if AMD is at all relevant any more and will get taken out by Intel finally.

This is similar to the fate that graphic chip designers were all finally consolidated into Nvidia (Nasdaq: NVDA) – which in itself might get munched by Intel. Its as good a time as any for consolidation in this entire PC sector.

Finally, it is always easy to point out share buybacks are a mistake when your stock is richly priced, but in Dell’s case, they have cumulatively spent $32.1 billion of cash on repurchasing 1.2 billion shares of stock – an average price of $26.79 per share. If from day zero they banked this cash and simply traded at a market cap of their net cash value (not even the higher book value), they would be trading at $11.93/share today. If they traded at the premium above book value as they are trading today, they would be at $15.26/share. Quite a bit of value destruction went on with those share buybacks.

Intel and Dell value traps

I notice Intel (Nasdaq: INTC) did a proactive release indicating that their third-quarter expectation is below their public target:

The company now expects third-quarter revenue to be $13.2 billion, plus or minus $300 million, compared to the previous expectation of $13.8 billion to $14.8 billion.

Intel is trading around a P/Es of 10, but it is a classical value trap. The company is a victim of a slower sales cycle – people no longer need to replace their PCs and notebooks every two years like they did a decade ago. Likewise, Intel is facing the declining technology refreshment cycle in addition to having traditional PCs/Laptops marginalized by tablet computers. Intel should be able to diversify enough that it can escape out of its trap over time, but I am not so sure about Dell – they are further entrenched in the traditional PC/Laptop market than Intel is. Dell has simply turned into another retailer, competing in a commoditized retail market. This is a recipe for margin shrinkage.

The market is also signalling this by virtue of Dell having a forward P/E of 6 based off of consensus analyst estimates. Anybody want to make a bet that those EPS estimates are going to go down next year? Right now they are saying $1.80/share.

I don’t have interest in either companies other than just following them for curiousity’s sake.