Is Dell a Deep Value or a Value Trap?


It's not that Dell (NAS: DELL) doesn't have a plan. The stock is plunging today because the company's chosen strategy exposes it to some painful bumps in the road. The result? A mixed message that only reinforces the thesis behind my CAPScall on Dell. Read on for all the juicy details.

Fool by numbers
In Tuesday's second-quarter report, Dell unveiled $0.50 of non-GAAP earnings per share on $14.5 billion in revenue. The bottom line shrank 7% year over year and sales slimmed down by 8%. But that wasn't Dell's cardinal sin -- analysts were looking for adjusted earnings of just $0.45 per share, and the revenue miss was just 1.3% wide.

No, the problem here is Dell's gloomy outlook for the third quarter. Management expects sales to fall 2% to 5% from this quarter due to tough competition, soft consumer demand, and uncertain macroeconomic assumptions. At the midpoint of that range, you'd get $14.0 billion -- far below the Street's $14.9 billion target.

The weak sales will cascade down the income statement, causing Dell to lower its full-year earnings outlook to $1.70 per share. Again, that's well short of analysts' $1.91 target.

Management underscores that its enterprise business is running smoothly while consumers let the company down. In the second quarter, business and government sales of all stripes fell by modest single-digit percentages but the consumer division crashed to the tune of 22%.

On a geographic basis, the worst offenders were found in the BRIC bloc, where sales fell 15%. India and China are abandoning laptops and desktops, too.

Putting the numbers in context
Don't let the raw numbers scare you.

All of this is actually consistent with earlier market reports from Microsoft (NAS: MSFT) and Intel (NAS: INTC) , both of which depend on business-class accounts for much of their growth these days. Furthermore, Dell's stated strategy assumes that consumer sales will fall off a cliff eventually.

"We're transforming our business," CEO Michael Dell said. "Not for a quarter or a fiscal year, but to deliver differentiated customer value for the long term." CFO Brian Gladden filled in the blanks: "We continued our progress in shifting the mix of our business to higher-margin enterprise solutions, led by solid growth in our server, networking, services, and Dell IP storage businesses."

In other words, Dell is leaving the ailing market for consumer systems to wither on the vine so it can refocus on enterprise sales instead. That's a higher-margin market, and also one where the inexorable rise of tablets and smartphones won't destroy existing opportunities. In fact, beefy back-end servers are a vital part of the mobile computing ecosystem, and they won't ever be replaced by truckloads of tablets.

So Dell's strategy is working where it needs to be, and failing exactly where you'd expect it to. I'm fine with that.

What's a Fool to do?
My bullish CAPScall on Dell is smarting today, having fallen more than 35% since I made the original thumbs-up call. I'd close that virtual position today if I saw a value trap developing, but that's not what's going on.

Instead, I'd agree with Topeka Capital analyst Brian White, who sees compelling value in today's sell-off on Dell: "The stock is likely to be under selling pressure, and we believe value investors may want to look at the stock on this pullback, especially given the valuation and our expectation that the sales cycle will trough" in the fourth quarter of this fiscal year.

In short, I'll ride this call for the long run. Dell is doing all the right things, even if that means scaring away short-term traders along the way. That's hardly a problem for value-conscious Fools.

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Fool contributorAnders Bylundholds no position in any of the companies mentioned. Check outAnders' holdings and bio, or follow him onTwitterandGoogle+. The Motley Fool owns shares of Microsoft and Intel.Motley Fool newsletter serviceshave recommended buying shares of Intel and Microsoft and creating a synthetic covered call position in Microsoft. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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