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Dell Stock Gains May Slacken

An eight-month climb in Dell's stock price may slacken after the computer maker tempered a previously upbeat forecast of business demand for PCs.

Dell (DELL) reported on Nov. 19 that sales sank 15% and net income tumbled 54% in its fiscal third quarter, which ended Oct. 30. What's more, Chief Executive Michael Dell suggested during a conference call after the results that businesses would take more time than previously expected to replace old computers with newer models running Microsoft's (MSFT) new Windows 7 operating system. "It won't all occur at once," he said.

The remarks contrasted with the CEO's contention in August that the PC industry would enter a "powerful product cycle" in 2010 that would benefit Dell. Wall Street "is going to feel like Michael Dell backed off a little bit on his comments on the replacement cycle," says one securities analyst, who asked not to be named since he hadn't yet published a research report on the quarter. "People are not going to like that." Dell's results look especially disappointing in light of a positive earnings report issued by rival Hewlett-Packard (HPQ) on Nov. 11.

Widespread Weakness Investors sold Dell stock in extended trading after the earnings report was released. The shares fell 6%. At the end of regular trading Nov. 19, Dell's stock closed down 19¢, or 1.2%, at 15.87. Shares of Dell have risen 55% so far in 2009, but that run could be ending. "If you're trying to invest for six months, it's not a great place to be," says Jayson Noland, a senior analyst at investment firm Robert W. Baird, who has a neutral rating on Dell. "It's a cheap stock, but I don't see any near-term catalyst" that might keep the rally alive, he said.

Dell said third-quarter sales were $12.9 billion, and net income was $337 million, or 23¢ a share after excluding certain one-time items. Wall Street analysts had expected Dell to earn 28¢ a share on sales of $13.1 billion. Weakness was spread across Dell's businesses, as sales to large companies declined 23% from a year earlier, sales to small and midsize companies were down 19%, and consumer revenue declined 10%.

Because 79% of Dell's sales come from corporate and government customers—the majority of that PC sales—the company has been particularly hard hit as information technology departments have kept a tight rein on spending, even as the economy recovers. "We are losing share in the aggregate" because of a heavy reliance on commercial sales, Dell CFO Brian Gladden told reporters during a conference call after the results were announced.

Dell's losses have meant gains for rivals Hewlett-Packard and Acer. HP remains the top seller of PCs worldwide, with 20.2% unit share in the third quarter, according to market researcher IDC. Acer was second with 14% share, and Dell dropped to third from second, with a share of 12.7%.

No Boost from Windows 7 Yet Windows 7, released Oct. 22, was supposed to jump-start flagging sales. Now, analysts say, companies are choosing to spend still-constrained technology budgets on other gear such as servers, disk storage, and networking equipment before they replacing aging fleets of PCs. "You will eventually see PC replacement, but it's three or four quarters away," says Baird's Noland. "In technology terms, that means we just don't know" when companies will begin replacing PCs en masse.

Many companies are hanging on to older computers that run Microsoft's Windows XP operating system, released in 2001, after having decided to skip the company's Windows Vista system, which debuted in 2007. At a meeting with Microsoft shareholders in Bellevue, Wash., on Nov. 19, CEO Steve Ballmer said Windows 7 sales have been "fantastic" since the product's launch, and that the software had sold twice as many units as any previous version of Windows in a comparable time span. Dell's third quarter closed only eight days after the release, and it's likely that much of the early Windows 7 purchases have come from sales of PCs to consumers.

Michael Dell has been trying to effect a turnaround at the company since he retook the reins as CEO early in 2007, and has expanded Dell's presence in consumer PCs sold in stores, a bright spot for technology sales over the past several years. But as Dell continues to cut costs and tries to preserve profitability, it "walked away from some retail business during the quarter" that wasn't acceptably profitable, Gladden told reporters in a separate conference call.

"We will absolutely stay biased toward profit," Dell said to analysts. Yet the company's gross profit margin in the third quarter was 17.3%, vs. 18.7% in the second quarter. Dell said its margin would have been 18.3% excluding one-time expenses related to the closure of a plant in North Carolina.

M&A Needed to Keep Pace with Rivals As companies spend to outfit data centers with more robust servers and networking gear, Dell may need to diversify further to keep pace with its competitors. On Nov. 11, Dell's chief rival, Hewlett-Packard, announced preliminary fiscal fourth-quarter earnings that exceeded Wall Street's expectations. Sales for HP's quarter, which ended Oct. 31, fell 8%, to $30.8 billion. Earnings, excluding certain one-time items, were $1.14 a share, vs. analysts' expectation of $1.11 per share. HP reported the results early as it announced that it plans to buy networking gear maker 3Com (COMS) for $2.7 billion.

Dell bought Perot Systems for $3.9 billion on Sept. 21 to expand in computer services. Analysts say it may need to buy more companies to expand in data center equipment. HP and Cisco Systems (CSCO) are squaring off in markets including servers and networking. And Oracle (ORCL) is trying to complete a $7.4 billion acquisition of computer maker Sun Microsystems (JAVA).

"We're heading back to a world where one vendor can become a kind of one-stop shop," says Noland. Dell's inability to hang that kind of shingle is causing it continued pain.
Ricadela is a reporter for Bloomberg News and Bloomberg Businessweek in Frankfurt.

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