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Quick Value 5.4.20
Dell Technologies Inc ($DELL)
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Despite an end of week selloff it was another week of strength in smaller cap stocks…
Hopefully this message about money supply and velocity isn’t getting repetitive…
Today, I wanted to share the Q1 2020 commentary from Hoisington Investment Management — LINK HERE
As a quick background on Hoisington: they have been bearish on economic output for quite some time and as such, they own primarily long-dated US treasury bonds (no stocks). Returns have been stellar for this strategy as interest rates have fallen for decades now…
The Q1 quarterly letter focused on the Fed’s expanding balance sheet and subsequent increase in money supply. Their view indicates this to be a red herring to economic output as these funds “are almost entirely being used to stabilize finances.” NOT for economic growth / expansion…
They go on to say…
The transitory surge in M2 and bank loans will not be sustained as a result of the weak financial conditions of the banks and other financial institutions as well as their business and household customers. The financial intermediaries will be weak for a variety of reasons – the yield curve is too flat, and loan losses will accelerate as result of the severity of the recession. Additionally, the highly leveraged corporate sector balance sheet and the general difficulty of paying back loans in the deflationary environment that lies ahead will restrain financial intermediaries lending.
One of Hoisington’s primary arguments for a deflationary future are the increased levels of unproductive debt… We’re using debt to plug an economic hole (not to grow new products / services) and it takes time and austerity to dig out of a debt-filled hole.
Just think about your own personal situation after you’ve borrowed for that new car, the new home, and your student loan debt all at the same time. Leaves less money for dinner, drinks, and “stuff.”
Will we see negative interest rates as it becomes harder to escape from the zero-bound?
Dell Technologies Inc ($DELL)
This is the eponymous computer brand of Michael Dell which was taken private via $24bn leveraged buyout in 2013 and then relisted as a public company in late 2018 through a complicated and controversial reverse merger with a VMWare tracking stock (which was created as part of a 2016 acquisition of EMC).
Michael Dell controls DELL via ownership of non-traded A shares. His control has left a bad taste in investor mouths after what many believed to be a bum deal in the VMWare reverse merger (i.e. “take under”). Perhaps there will always be a “Michael Dell Discount” in the stock.
But that’s all in the past, right?…
During the coronavirus selloff, Dell was personally buying the publicly traded class C shares at prices from $26-36 per share (vs. $40 today).
DELL has 740m shares outstanding. At $40 per share, it’s a ~$30bn market cap. Net debt is $43bn for a $73bn enterprise value. EBITDA is $10-11bn per year. Right around 7x EV/EBITDA. Fairly cheap.
Prior to withdrawing guidance from the coronavirus impact, DELL was anticipating ~$6.25/sh in FY21 earnings (6.4x PE) and another year of hefty debt repayments ($5.5bn expected).
About half of revenue comes from selling computers; another ~37% from data center hardware and services; and the remainder from the controlling interest in publicly-traded VMWare ($VMW) which is consolidated on DELL’s financials. DELL owns ~81% of the $52bn VMWare business.
The situation is interesting because it feels like a publicly-traded LBO that has made significant progress but the price doesn’t yet reflect that progress…
Shares are flat-to-down from the time of the reverse merger in Dec 2018
Removal of tracking stock structure, while potentially done on disadvantageous terms, simplifies the ownership structure of the business
Since acquiring EMC in 2016 — DELL has paid down $19.5bn in debt
Cash flow is strong — free cash flow (including VMW) was $17.5bn over the past 3 years, just shy of 60% of the current market value
…which allows them to repay debt quickly — $5.5bn in repaid in FY20 and another $5.5bn debt payments expected in FY21 = 18% of the current market cap
One way to think about the situation is that as debt is repaid in large chunks over the next few years, that value should accrue to equity holders — if they repay $2-3bn in debt each year with no change in valuation that would be ~7-10% of the market cap alone.
Another way to look at it is you own ~81% of VMW, which at $52bn = $56 per share to DELL shareholders. Plus, the value of DELL’s businesses. You can see the significant value in the VMW stake. The “sum of the parts” theory.
Interestingly, DELL was originally taken private back in 2013 at about 8x earnings which would make for a $50+ stock price today…
Check out the most recent investor presentation for more details.