Sunday, September 28, 2008
Dell listens to customers and delivers innovative technology and services they trust and value. As a leading technology company, we offer a broad range of product categories, including desktop PCs, servers and networking products, storage, mobility products, software and peripherals, and services. According to IDC, we are the number one supplier of personal computer systems in the United States, and the number two supplier worldwide.
Our core business strategy is built around our direct customer model, relevant technologies and solutions, and highly efficient manufacturing and logistics; and we are expanding that core strategy by adding new distribution channels to reach even more commercial customers and individual consumers around the world. Using this strategy, we strive to provide the best possible customer experience by offering superior value; high-quality, relevant technology; customized systems and services; superior service and support; and differentiated products and services that are easy to buy and use. Historically, our growth has been driven organically from our core businesses. Recently, we have begun to pursue a targeted acquisition strategy designed to augment select areas of our business with more products, services, and technology that our customers value. For example, with our recent acquisition of EqualLogic, Inc., a leading provider of high-performance storage area network solutions, and the subsequent expansion of Dell’s PartnerDirect channel, we are ready to deliver customers an easier and more affordable solution for storing and processing data.
As a result of the intensely competitive environment, we lost 1.9 points of share during calendar 2007. We lost share, both in the U.S. and internationally, as our growth did not meet overall personal computer systems growth. This was mainly due to intense competitive pressure in our U.S. Consumer business, particularly in lower priced desktops and notebooks, as well as a slight decline in our worldwide desktop shipments (compared to 5% worldwide industry growth in desktops). At the end of calendar 2007, we remained the number one supplier of personal computer systems in the U.S. and the number two supplier worldwide.
In light of this, let us look at Dell's bottom line.
Dell's cash flow from operating activities has a stable/declining trend.
CashFlow (millions) Year
In the current fiscal year, Dell's cash flow has continued to deteriorate compared to the previous year.
The primary reason for the decline is reduction in margin over the last two years compared to prior years because of intense competition. This year, the margin is even lower compared to the prior two years.
While Dell is a good franchise and will continue to have a world wide presence in the near term, the cash flow may take some hits. At the current prices, Dell doesnt look like a good investment when compared to some of the other opportunities available in the market.
Saturday, September 20, 2008
Fiscal year 2008 compared with fiscal year 2007
Revenue growth was driven primarily by increased licensing of the 2007 Microsoft Office system, increased Xbox 360 platform sales, increased revenue associated with Windows Server and SQL Server, and increased licensing of Windows Vista. Foreign currency exchange rates accounted for a $1.6 billion or three percentage point increase in revenue during the year.
Operating income increased primarily reflecting increased revenue, partially offset by increased headcount-related expenses, increased costs for legal settlements and legal contingencies, and increased cost of revenue. Headcount-related expenses increased 12%, reflecting an increase in headcount during the year. We incurred $1.8 billion of legal charges during the year primarily related to the European Commission fine of $1.4 billion (€899 million) as compared with $511 million of legal charges during the prior year. Cost of revenue increased $905 million or 8%, reflecting increased data center and equipment costs, online content expenses, and increased costs associated with the growth in our consulting services, partially offset by decreased Xbox 360 costs. The decreased Xbox 360 costs reflect the $1.1 billion charge in fiscal year 2007 related to the expansion of our Xbox 360 warranty coverage as discussed below, partially offset by increased Xbox 360 product costs reflecting growth in unit console sales.
The diluted earnings per share growth was impacted by the $1.1 billion Xbox 360 charge in fiscal year 2007 and current year share repurchases.
Windows client had revenues of 16.8 billion with 13 billion in income. The server and tools division had revenues of 13.1 billion and operating income of 4.59 billion. The Microsoft business division had revenues of 18.9 billion and operating income of 12.4 billion.
The remaining divisions and corporate level activity contributed to about 8 billion in losses or impairment. The other divisions include Online Services, Entertainment & Devices and Corporate Level Activity.
Overall, 59% of Microsoft revenues came from the US and the remaining from the rest of the world.
Microsoft is also in a buying frenzy spending about $12 billion in FY08 in buying companies that are publicly or privately held.
The interesting aspect of Microsoft's business is the unending investments in the search & ad space that is not yielding any fruit. More light was spilled on this in the yearly conference call.
QUESTION: Thank you. I just have some questions on the timeline here, sort of when Yahoo! collapsed. On May 3rd you disclosed your offer price of $33, on May 6th there was a quote from one of Yahoo!'s largest shareholders saying he was extremely disappointed with them. May 13th Icahn had bought a block of share. May 15th he had his board slate nominated, and my guess is by May 16th all of Yahoo!'s largest shareholders had told them that they would consider voting for the Icahn slate, and would be willing to sell for $33 a share. So that's just 13 days. It doesn't seem plausible that the asset depreciated that much in those 13 days. What really happened that made you decide not to pursue it at that point?
STEVE BALLMER: I'm glad you have the timeline, I lived it, but I don't have it sort of noted here in quite that detail. But we had a date we were going to make a decision. We came fully prepared to work. We didn't converge. There was no further I don't know, May 15th, 17th, some place in the teens, there was no it was over. The discussions stopped. Somebody wanted to sell us the business on May 15th, 17th, whatever some day was, it was unknown to me. We had a discussion. We had a discussion with the CEO of the company. We couldn't reach a deal. You move on.
The fact of the matter is, and Chris went through all of the rationale, I think, actually much more eloquently, in fact, than I did earlier in the day, and certainly much more crisply. You go through all of it, the market has changed, lots of things have changed. But we had a deadline based upon kind of what we wanted to accomplish, and time to market, and the deadline passed. And then we started looking at additional alternatives, and I know by Memorial Day we were having some discussions about a search deal, which was fine, and those, too, didn't work out. But by that time, we were really on to the search field.
CHRIS LIDDELL: I don't want to keep rewriting history, and the he said/she said sort of discussion that we've had way too much of. But when we launched the bid, we launched it with an anticipation that we would get serious engagement very quickly, and a decision very quickly. We -and if you had told me that May was going to be that point, I would have said, that's way too long. I think we made it very clear, right through the early stage of the acquisition, that something like March would have been great. The end of April suddenly became a drop-dead date. And at some point is the tipping point in all of these where it no longer makes sense to engage on the principle thing. I think we were clear right the way along.
STEVE BALLMER: It is a little weird. You could say Chris is a little bit crisper about these things than I am. But, man, we had an offer out that was 100 percent premium on the operating business of the company, and there wasn't really even a serious price negotiation until the beginning of May, which is three months later. Okay, that's just the way these things work. And yet, we had priced -you could say, why did you come in with an offer that was 100 percent premium on the operating business, but taking out the Asian assets. And the answer was, so we could get it done quickly. Chris still relatively new to tech, he said, are you kidding? No other business in the world would have this kind of patience. And yet, I think we've dealt a little bit with founders, and we wanted to give the thing some time. But at some point, as Chris said, you move on.
On the question of investing in search and related businesses:
I mean, I talked about, I think, tried to give you some characterization of what I thought that ante was. I talked a little bit about that. I talked about the potential of investing something like 5 to 10 percent of operating income for a period of time in order to go after it. It kind of gives you a little bit of a feel. We were between 5 and 10 percent this year. You could say it doesn't give you a precise feel. I'm never precise about things that are forward looking, because it doesn't seem to be all that useful, unless we're willing to be super-precise, and that's what we call guidance.
On opex cost:
Chris said maybe it made sense for me to explain just a little bit how we think about FY '09, and where we're spending money. We announced that our OPEX would be up something about $4 billion in FY '09 versus FY '08. I'm not an expert, but I bet if you back out growth in operating expenses at stores in Wal-Mart, that ranks right up there as one of the largest increases in operating expense year over year of any company in two sequential years. So let me give you a little context.
Microsoft's search business investing and the distress in the financial industry is likely to taper growth in its core businesses this year. While the share buy backs should help the earnings, that alone might not be enough.
Even though Microsoft is historically cheap, it still doesnt look like a bargain at these prices. A company like Walmart seems to offer more upside than Microsoft at the moment.
Saturday, September 13, 2008
Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings. The exception was Wells Fargo, a superbly-managed, high-return banking operation in which we increased our ownership to just under 10%, the most we can own without the approval of the Federal Reserve Board. About one-sixth of our position was bought in 1989, the rest in 1990.
The banking business is no favorite of ours. When assets are twenty times equity - a common ratio in this industry - mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.
Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices.
With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen. In many ways the combination of Carl and Paul reminds me of another - Tom Murphy and Dan Burke at Capital Cities/ABC. First, each pair is stronger than the sum of its parts because each partner understands, trusts and admires the other. Second, both managerial teams pay able people well, but abhor having a bigger head count than is needed. Third, both attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, both stick with what they understand and let their abilities, not their egos, determine what they attempt. (Thomas J. Watson Sr. of IBM followed the same rule: "I'm no genius," he said. "I'm smart in spots - but I stay around those spots.")
Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.
Wells Fargo is big - it has $56 billion in assets - and has been earning more than 20% on equity and 1.25% on assets. Our purchase of one-tenth of the bank may be thought of as roughly equivalent to our buying 100% of a $5 billion bank with identical financial characteristics. But were we to make such a purchase, we would have to pay about twice the $290 million we paid for Wells Fargo. Moreover, that $5 billion bank, commanding a premium price, would present us with another problem: We would not be able to find a Carl Reichardt to run it. In recent years, Wells Fargo executives have been more avidly recruited than any others in the banking business; no one, however, has been able to hire the dean.
Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.
None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.
A year like that - which we consider only a low-level possibility, not a likelihood - would not distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity. Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices.
The prices are definitely not what Buffett paid for in 1990 but it still makes for a good investment.
Let us fast forward to 2008 and see how things stand at Wells Fargo. The ROA is 1.27% and ROE is 15.5%. The stock is going at a P/E of 15.9 and and a ratio of 10.8 before taxes at current prices.
The company has 47.6 billion in equity and 400 billion in loads. The debt to equity ratio is about 11. However, the conservative underwriting is helping the company weather the financial storm pretty well. The upside is somewhat lower at current prices but looking at the stock price + yield makes this stock still very attractive.
Monday, September 01, 2008
AEO is now expected to earn about $1.41/share this fiscal year and things should improve around 2010 when the issues with women's apparel and Martin and Osa brand is fixed. Also, one should look at new product lines coming up. The American Eagle brand has reached saturation ( or about to reach saturation ) so all the cash flows must come from other brands.
Let us look at the numbers for a moment. While the top line increased by 4.5%, the bottom line decreased by 44%. ( excluding interest income ). The decreased number of shares helped hold the earnings per share somewhat respectable in this environment. The company has focussed on holding market share in this difficult period.
Management has provided guidance that the second half of the year is more likely to be like the first half without much improvement.
Let us look at some of the other things the management did. The company had 703 million dollars in cash and equivalents. In a dumb move, the company decided to hold some of the cash in auction rate securities which are illiquid. It is a move the management made most likely to get higher yield, yet management found that most of these securities are illiquid in the absence of other bidders. Now the company is forced to keep its securities till maturity. This ties up valuable cash that can be used for stock purchases held till maturity. The risk of default of the counter party is also unknown.
Deducting the 703 million dollars from the market cap, the company has 2.3 billion in market cap. ( ofcourse, this is assuming the auction rate securities will mature and can come into hand). The cash flow without including capex is around 490 million. The capex number is expected to drop next year which should bode well for this stock.
The management should aggressively buy back stock at these levels since the majority of stock buy back happened in the mid twenties. Instead of deploying the cash in dubious investments like ARS, stock buy back will provide most value for the stock holders at this time.
I still believe that the company's stock is attractively priced. The company carries no debt and has improved its inventory management. The company ships products in sixty+ countries via the internet. The gift card business provides about 4 million dollars ( annual ) revenue. If the company executes well and buys back stock, we can easily see this issue in the high twenties or low thirties in two-three years time.