2HRS2GO: Dell's business matures

COMMENTARY -- You can always count on the buy-side guys to ask the questions that investors are truly asking.

Dell Computer (Nasdaq: DELL) yesterday reported uninspiring third quarter results and a disappointing fiscal 2002 outlook, including an expectation of 20 percent revenue growth. With that hovering in the background, only one question really mattered to investors during the quarterly conference call, and it came from an analyst for money management firm Lord, Abbett & Co. The dialogue was less than encouraging:

Analyst: "Can you give us a little more color on the 20 percent revene growth target for the coming fiscal year, particularly given that a number of the markets that you're targeting have growth expectations that are in excess of that rate?"

Dell CFO James Schneider: "We don't ordinarily really give an annual growth rate at this point in time of the year, but there's just been so much concern over the revenue growth rates and what they might be, that we wanted to at least give some preliminary guidance on what we're looking at right now.

"I think while we expect to have really good growth in the enterprise and notebook space, we are seeing a great decline in component costs, and again, if I look at average selling prices coming down 4 percent in the quarter, as to how those component cost trends may go out into next year, it's a little early to tell, but we wanted to give some guidance based on where we are now.

"We're more focused on the enterprise products and notebooks, and see the desktops growing at a much lower rate, so I think 20 percent would still be a multiple of what the market is, and when I look at it from an overall standpoint, it's still $6 billion of revenue growth on a sequential basis."

CEO Michael Dell: Clearly there's a mix shift going on here to servers, storage, svces and notebooks, and we believe that for a company of our size, a 20 percent growth rate is not only quite strong, but relatively unprecedented for companies of that size, and as Jim mentioned, we're going to provide more insight into our next year outlook at the end of the fourth quarter."

The analyst asked for color. If you can find a hint of color (gray doesn't count) in that response, please let me know.

And that's why Wall Street is brutalizing DELL shares today. Dell used to be a company that sounded dynamic and exciting. Now its executives sound like this:

"You made a comment a little bit on pricing, I don't know if it will be more aggressive than we've kind of reached at this point. It's clearly been more aggressive in our third quarter than it was in our second quarter (when), as Michael alluded to, our competitors got better and we laid off the pricing lever and we slowed our growth.

"We're going to continue to use the benefits of the direct model, one of those is leveraged pricing, but that's going to be consistent with what you've seen from us in the last 10 years, nothing that's kind of accelerated or extraordinary."

Perhaps Lord, Abbett & Co.'s analyst stimulated his sell-side counterparts to poke around a bit more. Analyst Kevin McCarthy of CS First Boston suggested that at some point, Dell's desktop PC business may actually shrink next year. McCarthy noted that given the strong expansion rate of enterprise fields such as storage area networks and attached storage, "if you grow at industry rates in some of those markets, the math to get to 20 percent would have to make the desktop business fairly low growth and perhaps even negative growth."

Michael Dell: I think it's back to what we talked about earlier, on how the component costs declines worked out and what the average selling prices are for desktops, whether we see better unit growth than revenue growth on desktops.

Throughout the call, Dell executives asserted that revenue was affected to some extent by lower costs. As parts become cheaper, Dell can cut system prices, hence lower revenue per unit without hurting margins.

It's not that the third quarter report was so bad, or that Dell is a terrible company. But Wall Street still hasn't received an adequate salve for its central concern: why can't Dell boost revenue faster? Executives' litany of non-answers convinced at least three analysts to downgrade Dell today, while a fourth reiterated a "neutral" (read: bad) rating.

Dell's large revenue base notwithstanding, if all the company can deliver is 20 percent growth, investors can justifiably ask themselves why they should bother DELL. Might as well move DELL money into General Electric (NYSE: GE), which also delivers 20 percent growth -- but produces as much revenue in one quarter as Dell does in an entire year. In fact, GE carries a higher P-E ratio than Dell, so perhaps many investors have already drawn that same conclusion.

Yet some folks continue to think of Dell as an aggressive growth company. Yesterday's conference call made it abundantly clear that Dell is anything but. 22GO>