Tickers in this Article: DELL, HPQ, IBM, CSCO, EMC, AAPL, NTAP
I have often written that value really does not matter in technology investing. This is a sector driven by growth, not valuation, and it is all too rare for cash flow-based analysis to carry the day. That makes Dell (Nasdaq:DELL) a very difficult stock to evaluate. If the company can deliver anything close to its projected free cash flow, the stock is shockingly cheap. But with revenue growth so low - and likely to remain sluggish - it may be hard to attract any investors who care.

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A Complicated Second Quarter
Dell is trying to transition from being largely a consumer-driven PC company into a fully-integrated enterprise IT provider. So far, the results continue to be mixed. Revenue grew just 1% over last year's level, but 4% from the first quarter - a result that nevertheless missed analyst expectations.

Enterprise demand was respectable and helped offset ongoing difficulties in the PC and notebook business, where Dell continues to struggle to maintain momentum against rival PC-makers like Hewlett-Packard (NYSE:HPQ) and Acer and PC alternatives like Apple's (Nasdaq:AAPL) iPad. Server and networking revenue was pretty strong (up 9% year on year and 4% sequentially), software revenue was flat and service revenue was also positive. Storage was the laggard on a reported basis, as the company transitions away from EMC (NYSE:EMC), but Dell-owned storage technology revenue was up 15%.

Margin performance was pretty good, all things considered. Gross margin slid 40 basis points on a sequential basis, but was up almost six full points from last year. Likewise, operating income rose more than 50% from the year-ago level. (For related reading, see A Look At Corporate Profit Margins.)

Progress And Self-Promotion
Dell has gotten a lot of scrutiny during its transition and a lot of criticism for its questionable success in building upon a spate of expensive acquisitions. Perhaps management is getting a little touchy, as Dell's earnings release was unusually self-promotional and went out of its way to highlight areas of progress. This is admittedly a "squishy", non-quantitative factor, but this is the sort of corporate body language that investors should pay more attention to when considering investments.

That said, Dell is making more progress than analysts seem to want to credit. Underperform ratings are still fairly uncommon on Wall Street, but Dell has more than a few of them. That is despite the fact that the company seems to be doing pretty well in services - where companies like IBM (NYSE:IBM) and Hewlett-Packard have been struggling - and doing at least ok in servers. The storage business is a little harder to figure out - 15% internal growth is not bad, but it hardly seems that EMC or NetApp (Nasdaq:NTAP) are really sweating the threat of competition from Dell. (For related reading, see Analyst Recommendations: Do Sell Ratings Exist?)

The real $64,000 question for Dell is how far it can succeed with its growth plans. Dell wants to grow in servers, but so do IBM, HP and Cisco (Nasdaq:CSCO). What does Dell have in its bag of tricks to gain share other than competing on price? Likewise, in arenas like services and PCs, can Dell really build a technology advantage that will give it even a narrow moat in the future?

The Bottom Line
For all of that criticism and skepticism about Dell's ability to compete, it is also important to look at the stock and see what is already in the valuation. Assuming that Dell meets the new full-year revenue guidance and maintains its current free cash flow margin and then sees free cash flow decline 4% forever more, the stock should be worth something in the neighborhood of $20 to $22. For the stock to be selling below $15 (at least as of the morning after results), that would suggest an enormous degree of pessimism regarding Dell's prospects.

Dell cannot be the next Apple and it is not even trying. Dell may be pursuing a model that looks similar to that of IBM or Hewlett-Packard, but Dell does not have the strong legacy businesses of IBM (mainframes) or HP (printing). Even still, my cash flow model suggests that Dell's business is priced for erosion in excess of 10% a year - in other words, Wall Street is pricing Dell for an Atari or Gateway-like slide into abject irrelevance.

Value calls are tough to make in technology, as the core investor group often just doesn't care about that. Even still, and even taking a dim view of Dell's strategic decisions and forward growth prospects, it is hard to see how Dell's price is anything close to fair. For patient investors, then, this could be a multi-year opportunity to unlock major value if management can deliver on even modest expectations. (For more on value calls, see The Value Investor's Handbook.)

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