TFD9 Pre-work: Dell

I’ve looked at Dell a couple of times already, once before Dell World 2012, and once after the go-private thing was announced. I went back and read over my previous stuff, so you probably should to, because I’ll be referring to it.

Since we last looked at the company, Dell’s 2013 financial statements have come out. To summarise: Sadface. :(

Sadface

Why? Here’s why:

Dell ROE and ROA chart

Dell's historical ROE and ROA

Dell’s ROA continues to decline, and because their leverage is still up at 4.45, the decline in ROE is magnified.

Ok, but why did ROA go down? Two reasons. The first is that assets went up. This is mostly because of all the acquisitions Dell made in the past year, which bumped up total assets from $44.5bn to $44.7bn. Dell sold off some short-term investments to help pay for it, and most of it ended up in Intangibles and Goodwill.

What they hell are they? Intangibles are things that aren’t ‘real’, but are nonetheless specific and their value can be assessed. Stuff like patents, trademarks, contract rights and so on. Goodwill is basically whatever you pay over and above what the ‘real’ assets of a company are. It’s the brand, the vibe, and the general feelings of “goodwill” people have towards a company. It’s accountants attempting to record why you paid more than the company was “worth” according to its tangible and intangible assets, or “book” value. Dell bought nearly $5bn of intangible assets and Goodwill.

And now we come to the second reason ROA went down: Sales went down. Quite a lot. Overall, about $5.1bn, or a bit over 8%, and it was mostly because of poor product sales, which went down 10.34%. Services sales actually went up a bit, but nowhere near enough. Now ROA is Net Income/Assets, and Sales != Net Income. You have to take off costs, both fixed and variable.

Variable costs, COGS, went down by $3.5bn, so not enough to compensate for sales dropping by $5.1bn. There was a small reduction in fixed costs, but only about $200million, so not enough.

Here’s my old-favourite DuPont chart for further illustration:

Dell DuPont Analysis Chart

DuPont Analysis for Dell

And there’s your asset turnover decline. Leverage is reducing, so it’s less damaging to ROE, but asset turnover is still going down. Operating efficiency has dropped back a bit, too.

Decline and Distraction

What we have here is a story of decline in product sales, which has been coming for a while, and services sales not picking up fast enough to compensate. Dell made some big acquisitions, and those assets go straight onto the balance sheet. With most acquisitions, there’s a period of transition, so you won’t necessarily get an immediate bump in sales. If it’s a pure stock buy, then sure, but if it’s something you have to integrate into the rest of the business, well, that takes time.

And that’s Dell’s problem. They’ve made a bunch of acquisitions, and are trying to turn the company around, but it’s taking too long to do. And that’s exactly why Mr. Dell wants to take Dell private again, so that he can move more quickly, without having to worry about what the stock market thinks.

Somewhat ironically, the process of taking the company private is no-doubt distracting a lot of staff as well, particularly senior managers. Some will be worried for their jobs. Some should be.

Dell might be returning over 22% ROE, but that’s all due to leverage. Recall that Commvault has ROE of only 15%, but ROA of 8.7% and leverage of 1.7.

Some other ratio stuff that concerns me is the decline in Current Ratio to 1.19 and Quick Ratio down to 0.83, but it all boils down to not generating enough sales from the amount of assets Dell has. They’ve got to get their acquisitions working harder for them.

What’s Next for Dell?

The solution to Dell’s woes has nothing to do with their capital structure and everything to do with good old fashioned sales and marketing. They need to sell more stuff, preferably services which have lower costs. People just aren’t buying PCs the way they were any more.

I look forward to hearing from Dell about what they have planned. I’ll be listening closely for signs that Michael Dell’s overall vision is percolating through the company.

Because it has to.

 

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