Dell Technologies (DELL), just off another public offering, is selling for a cheap valuation in terms of price to forward non-GAAP earnings and sales, yet has way too much debt to buy. Many bull cases are using EBITDA to evaluate Dell which is eliminating the larger problem and covers up the issues with profitability. Following Benjamin Graham’s value investing strategies, we are not only looking for solid profitable companies with growth opportunities, but we must ensure that we are buying them at a reasonable or low price. The important part here is to determine if the issue is selling cheaply enough to consider buying. Dell logged a GAAP diluted EPS of $0.38 in Q1 and a Non-GAAP diluted EPS of $1.45. Dell has not had a positive year since 2013 providing some worry about the reliability of these earnings.
Dell Earnings Reports Under a Microscope:
Dell logged a GAAP EPS of $0.38 per share in Q1 of their 2020 fiscal year(starts beginning of February). The Non-GAAP EPS was $1.45 crushing analyst projections by $0.25, but missing revenue numbers by over $250 million. While this looks like a solid entry into profitability for the company, looking closer at the income statement tells a different story. On the GAAP report, Dell actually lost money with an operating income of $550 million followed by “Interest and Other, net” expense of $693 million netting a loss of $143 million. This would come out to a loss of $0.1855 per share. However, a tax break accounts for $472 million thrusting the quarterly loss into a quarterly profit, but not due to operations.
The cheap FWD P/E is also using Non-GAAP earnings, which Dell has repeatedly thrown out over a billion dollars’ worth of expenses thus explaining the huge jump from a GAAP EPS of $0.38 to a Non-GAAP EPS of $1.45.
The large difference is the addition of amortization of intangibles, which is an unrealized gain as it is merely the valuation of goodwill and other intangibles. Meaning that when all is said and done, that cash is not available to pay off outstanding debt or go towards other financings such as R&D. In reality, Dell has taken huge losses in the last few years despite their non-GAAP reports showing good profits. Since these earnings reports do not actually show much profitability with a poor track record since 2013, the optimistic earnings reports and cheap valuation do not make much sense especially since most FWD P/Es are using the non-GAAP EPS.
Poor Financial Strength And Capital Structure:
Dell has a poor balance sheet with a current ratio at 0.77 showing more current liabilities than current assets, always a red flag, and Graham hopes to see current ratios over 2 to ensure ability to pay any unexpected expenses and exhibit financial safety. The massive amount of debt has been weighing heavily on income and earnings as Dell has paid over $6 billion over the last three years in net interest per Seeking Alpha.
Management has forecasted paying off $4.8 Billion worth of debt over this fiscal year (started early Feb). However, this would be coming out of available cash and not from operations due to negative GAAP earnings. Paying off $4.8 Billion also sounds like a substantial amount for only one year, but this would be less than 10% of their total debt which has now accrued to over $53 billion signalling that hefty interest payments are not going away anytime soon. In their Q1 2020 fiscal year review, Dell only paid $400 million in debt but is set on paying $4.8 billion by the end of the fiscal year. That leaves $4.4 billion of debt to be paid off in three quarters for a company that with a $473 million tax return only profited $143 million in the first quarter. Now, while they do have the cash available to pay off this amount of debt, a $4.4 billion deduction in cash would wipe out almost half of their available cash.
Potential Risk due to High Debt:
As shown below, for this year alone, Dell will have to pay another $2.18 billion in interest. Dell claims they will pay off $4.8 billion, but they owe payments for $7.88 billion with another whopping $2.18 billion in interest for a net obligation of over $13 billion. For a company that cannot even make a profit, this poses a huge threat to their liquidity and future operations. These payments also won’t stop anytime soon as currently, Dell will have to pay over $16 billion in interest payments.
With just under $10 billion in cash, most of this will have to be used in the next year to pay off debt and interest. Due to poor operational cash flow, Dell will then be forced to take out more money in either stock distributions diluting shares or more loans. One bright spot is that Dell did have a positive operating income of $427 million last year for the first time since 2013. However, only making $427 million isn’t enough to reliably be able to continue to pay future cash obligations without adding more debt.
Dell will have to pay $44.919 billion by 2023. In order to pay this without adding more debt, Dell would have to earn a minimum of about $35 billion by 2023, which is clearly not plausible as their best yearly earnings in the last decade were $4.48 billion back in 2012. This is a recipe for disaster as the debt will continue to pile up further extending interest payments.
Evaluating the Bull Case for Dell:
Many valuations including Seeking Alpha’s top idea still claim that Dell is heavily discounted by comparing Dell’s EV/EBITDA to the rest of the sector. This does not make much sense to me. Enterprise Value is simply calculated by taking the Market Cap subtracting Cash and adding Debt. Then EBITDA is earnings before interest, taxes, depreciation, and amortization. These two valuations are skewed and do not show the true picture of a company especially of a debt heavy company such as Dell. The Enterprise Value is now over double Dell’s market cap due to the $53 billion in debt. Using these metrics Dell now looks as a highly profitable and undervalued company as their 2019 EBITDA was $7.962 billion as opposed to the 2019 net loss of $2.31 billion. Many reports and analysts are using these metrics to cover up the underlying fact that Dell is having a hard time dealing with the heavy interest and intangibles.
Graham loves using tangible book value to accurately assess what real assets each share offers. Dell’s tangible book value per share is an atrocious -$95.61 with an overall tangible book value of -$68.7 billion per Seeking Alpha. Dell’s $111 billion of total assets is made up with over $62 billion worth of intangible assets. Also with more total liabilities ($112 billion) than total assets makes Dell’s financial situation stressful. In essence, buying one share now at $55 would be buying -$95.61 worth of tangible assets and would then be buying into debt and goodwill/intangibles.
Dell’s Book Value also dropped into negatives this past fiscal year with the book value per share equal to -$8.02. Having more liabilities than assets always poses a threat for liquidation and long-term potential of bankruptcy.
Despite all of these concerns, the median price target is $70 showing a 25% upside. However, all of these price targets seem to be based on Non-GAAP earnings which as mentioned earlier portray Dell as a growing and extremely profitable company with an EPS consensus estimate of $6.46. Yet, Dell will record more billion-dollar losses.
Overall Verdict: Risky with Minimal Reward
With Dell’s hefty debt load and large amount of intangible assets, Dell is just too risky at this point. With no end to the debt in sight, interest and debt payments will continue to weigh on future operations, earnings and cash flow limiting possibilities for R&D as over half of current cash on hand will be used to pay off another $4.4 billion this fiscal year. Stay away for now.―Seeking Alpha