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Dell Reports Q2 Earnings; Who Thought This Would Turn Out Well?

Posted on | August 29, 2008 Time: 7:12 am |

There was a modest batch of semiconductor and consumer tech related companies reporting earnings today, with Dell (Nasdaq: DELL) being the feature tone-setter. They came in with a 3-cent miss (after backing out those pesky “business realignment” charges), saw gross margins drop 120 basis points sequentially, and investors are bracing themselves for the fleshing out of the 10% drop posted in the early going of the after hours session.

For the semis, it was the tail end of an overall weak reporting period, with a few focused exceptions. The industry is facing two uphill battles in slowing global growth, and the delayed creeping in of higher input costs. Margin troubles abounded at OmniVision Technologies (Nasdaq: OVTI), while Marvel Technologies (Nasdaq: MRVL) came in OK, but off the very easiest of comparisons.

HP is Leaving the Sandbox

Hewlett-Packard (NYSE: HPQ) just reported last week; they had an 14% bump in net earnings to Dell’s 17% drop. HP now has the far superior assets in services and software, both of which lead to those lovely recurring revenue streams. I always thought EDS was a little undervalued by the market because of the vagaries of their long-term contracts, so the ~$14 billion pickup should be quickly accretive to earnings.

So long as Hewlett CEO Mark Hurd doesn’t completely fumble the EDS integration, HP isn’t even fair to compare with Dell anymore. HP is on its way up the ladder to challenge IBM for global IT “must-have” partner supremecy. Dell is left to battle it out with the increasingly commoditized PC arena.

Good luck, Michael – you’ve taught an entire industry how to play the game, but unfortunately it doesn’t count as intellectual property.

Parting Thoughts

I couldn’t recommend owning any of these names right now. The valuations are certainly fair (if not compelling), but the U.S. consumer is a really scary bet. And while I’m still optimistic on secular global growth trends, investors should consider the 5% to 6% global growth we’ve seen over the past few years as more anomaly, less norm.

I would look at IBM in the range of 12x trailing earnings or better, and HP only after proving they can clear out the internal webbing of EDS. With the dollar picking up some strength, any incremental clarity in the economy’s future may be netted out by a loss of favorable conversions on the more than $50 billion in overseas revenue IBM earns each year.

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