It should have sales of $88 billion this year. It also owns 81% of VMware (NYSE:VMW), which is worth $60 billion.
On the surface it makes no sense. Valuing Dell’s stake in VMware at $48 billion means the rest of Dell is worth $2 billion?
Therein lies our tale. Let me explain.
Back in 2016, Dell bought EMC, which controlled VMware, for $67 billion. Four years later debt from that deal, $45 billion of it to be exact, remains on Dell’s books. VMware, meanwhile, has debts of just $3.8 billion, and a cash balance of $3 billion.
That means the enterprise value of Dell, including its debt, is $95 billion. That’s close to IBM’s market cap of $108 billion, but “Big Blue” itself has long-term debts of $58 billion, much of it accumulated in buying VMware competitor Red Hat. This means its enterprise value is closer to $165 billion, on revenue of $77 billion.
VMware and Red Hat are valuable because they offer virtualization and other cloud infrastructure software. It’s the kind of franchise the market often values at 10x revenue and more. VMware had sales of about $11 billion for its 2020 fiscal year, which ended in January.
The bottom line is that the market deems computer hardware operations to be nearly worthless unless they’re wildly profitable, like IBM’s Z-Series mainframes. Dell’s EMC servers, its Dell laptops, its Alienware gaming machines, everything CEO Michael Dell has built since he started assembling PCs in his University of Texas dorm in the 1980s, gets no love from Wall Street.
Break It Up
It’s not like Dell stock is worthless. The company had fiscal 2020 net income of $4.6 billion. But analysts think VMware could be worth $15 to $20 per share more, nearly $10 billion, if it traded on its own. VMware CEO Pat Gelsinger agrees, adding VMware could hook up with more hardware vendors if independent.
Selling VMware would also bring Dell enough cash to retire its debt and compete more closely against Hewlett Packard Enterprise (NYSE:HPE). HPE is currently killing it in “hyperconverged” hardware, a key data center market, and now matches it in server market share.
A spin-off is planned, with Dell and hedge fund partner Silver Lake maintaining a majority stake but no cash being raised to retire the debt. Moreover, the split wouldn’t happen until September 2021. “We are not selling VMware,” Dell states flatly.
For now, Dell is downsizing. Layoffs have begun, along with a pay freeze the company insists is unrelated to the pandemic. Even VMware is dropping employees. VMware workers who leave Silicon Valley and continue to work from home will also have their pay cut.
The Bottom Line
If you bought Dell stock at its pandemic low of $29 share in March, you have more than doubled your money. The latest machinations should unlock more value, although you may need to wait a year to see it. If Dell’s layoffs can double the company’s profits, to $9 billion, putting a market multiple on that doubles your money again. You also get stock in VMware if you buy now.
Take it all together, and a patient investor should do well buying Dell here. The same is true of Dell himself, now worth $38.2 billion according to Forbes.
At the end of the day, of course, Dell Technologies needs to regain its market momentum, with a smaller staff. That’s the main risk in the stock right now, along with interest rates on the debt. But it appears to be reasonable.
At the time of publication, Dana Blankenhorn held no positions in stocks mentioned in this article.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of the environmental thriller Bridget O’Flynn and the Bear, available at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn.