Dell Initiates A Price War In PC Industry

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Dell Inc. (NASDAQ:DELL) reported first quarter earnings yesterday that fell short of Wall Street estimates despite revenues coming above analysts’ expectations. Revenues fell 2 percent YoY to $14.1 billion, compared to the consensus estimate of $13.5 billion. However, EPS of 21 cents was far less than the consensus estimate of 35 cents a share.

Dell Inc

Deutsche Bank AG (NYSE:DB) (ETR:DBK) said in its latest research report that the heavy decline in profitability was due to the company offering significant discounts to its corporate customers, and shifting its strategy towards gaining market share. As a result of discounting PC prices, Deutsche Bank lowered its FY2014 EPS estimate from $.150 to $1. It has a $13.65 price target on the stock with Hold rating.

Steep discounting to regain market share ate up into Dell’s profit margins. Profit margin for the quarter was 4.2 percent and operating profit stood at $590 million. That was lower than Deutsche Bank AG (NYSE:DB) (ETR:DBK)’s estimate of 5.9 percent and $800 million respectively. Analysts believe that Dell couldn’t pursue the strategy of offering discounts as a public company. Now it is taking a long view, sacrificing short-term profits to strengthen its position in the market. For the same reason, analysts believe that profit margins will remain under pressure through FY2014.

Dell’s $13.65 Offer Now More Attractive

Deutsche Bank AG (NYSE:DB) (ETR:DBK) said that the latest quarterly results make the all-cash offer of $13.65 per share look more attractive given declining PC profits and uncertainty over mid-term earnings potential. Though Carl Icahn may change the strategy after the deal, increasing prices after they have been cut has rarely been successful. Deutsche Bank analysts said that’s why Dell Inc. (NASDAQ:DELL)’s future earnings potential under Carl Icahn’s scenario is uncertain and problematic.

Investment Thesis

Analysts believe that Dell’s stock will continue to trade near current levels. The weak revenues from the PC division were offset by strong growth in Servers. The Enterprise Solutions Group, which consists of networking, storage and servers, rose 10 percent YoY to $3.09 billion. Overall, the company has revised its pricing structure to focus on market share instead of profit protection, which will affect Dell’s cash generation and future profits. Deutsche Bank AG (NYSE:DB) (ETR:DBK) believes that Dell Inc. can execute this strategy only as a private company, as this strategy creates uncertainty about mid-term earnings. The quarterly result has incrementally made the all cash offer more lucrative for investors.

Dell Inc. (NASDAQ:DELL) shares were up 0.07 percent to $13.44 at 11:32 AM EDT.

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