For whatever optimism Cisco (Nasdaq:CSCO) and NetApp (Nasdaq:NTAP) generated with respectable quarters, Dell (Nasdaq:DELL) rained on the parade with another weak result. Not only did Dell miss again, but the company seems to be badly lacking momentum in any of the sort of markets that would excite investors. While there is (and has long been) underlying value in this business, it's anybody's guess as to when the bleeding is going to stop.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Third Quarter Results Fairly Depressing
There was no reason to think that Dell was going to have a great quarter, but it was still worse than expected and that's been a theme at Dell for far too long now.

Revenue fell 11% from last year's third quarter (which was flat from the year before that), and down about 5% from the second quarter. Declines were led by a feeble computer business that was down 18% (with notebooks down 26%), while software/peripherals were down 11% and storage was down 16% as reported (and down 3% looking through to Dell-owned IP). Servers and networking was the lone bright spot, up 11% as reported or 5% on an organic basis.

Dell also continues to struggle with its margin leverage. Non-GAAP gross margin fell a point from last year and about 60 basis points from the second quarter (GAAP performance was somewhat worse), even with the inclusion of Quest's significantly higher margins. Non-GAAP operating income fell almost one-third from last year and more than 20% from the second quarter.

SEE: Understanding The Income Statement

The Song Stubbornly Remains the Same
I suppose that Dell's performance with desktops and notebooks shouldn't be much of a surprise. It's not as though Hewlett-Packard (NYSE:HPQ) has been strong either, but I'm nevertheless surprised at the relative performance of Dell and Lenovo.

I understand that mobile devices from Apple (Nasdaq:AAPL) and Samsung have changed the computing world forever, but Dell has had time to adapt and has so far failed to do so. That also makes me wonder if Dell's server/networking momentum could ultimately be vulnerable to Lenovo down the line.

Dell also continues to struggle with its storage business. While its adjusted performance was better than IBM's (NYSE:IBM) 10% decline in the third quarter, there's nothing here to suggest much momentum relative to EMC (NYSE:EMC) or NetApp , and I believe that Dell will likely have to invest more resources (another acquisition?) to really compete.

SEE: Analyzing An Acquisition Announcement

On the software side, I don't believe Dell is done yet. Quest was a good deal and an underappreciated company, but I don't think it's enough to really give Dell a solid platform for enterprise software customers.

Is the Customer Concentration Deleveraging the Business?
As part of the company's revenue reporting, Dell announced that revenue from large enterprise customers was down 8%, while public revenue fell 11%, and consumer plunged 23%. In contrast (and continuing something of a trend), the small/mid-sized business (SMB) category saw only a 1% decline.

SMB has been an area of strength for Dell before this quarter, but I do wonder about the cost. It's more expensive to serve this niche/category, and I wonder if that's part of the margin compression problem. Said differently, Dell can't succeed without better performance in large enterprises and government verticals.

The Bottom Line
Dell clearly cannot continue on this path. Year-to-date free cash flow is down by about half, and investors seem to have largely lost confidence in the Dell business plan. At a minimum, management needs to stem the year-on-year profit declines and then formulate a long-term plan that's consistent with the realities of the IT world.

At the risk of stating the obvious, a lot of Dell's fair value today revolves around how much worse things get before the company stabilizes. If you assume that Dell's free cash flow declines from the fiscal 2012 level at a 15% compound rate for a decade (and 5% thereafter), that gets you to a fair value a bit over $9. Obviously, then, Wall Street is factoring in a lot of pessimism, but anybody buying shares today on a value/turnaround call had better be prepared to wait, because the Street clearly doesn't believe that Dell has a workable plan today.

At the time of writing, Stephen D. Simpson owned shares of EMC since 2012.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center