EUR 850.00 For Business Accounts Only

Morningstar | Initiating Coverage of Dell Technologies With a FVE of $56

We are initiating coverage of Dell Technologies with a $56 fair value estimate, no-moat and stable moat trend ratings, and we view shares as modestly undervalued today. As a very different firm than the Dell that went private in 2013, Dell Technologies offers a complete end-to-end product portfolio for IT infrastructure and is a leader across its major revenue streams. Substantial exposure to commoditized markets, a considerable debt load, and limited shareholder voting power drive our very high uncertainty rating.

Born out of Dell's 2016 acquisition of EMC, Dell Technologies is a pre-eminent vendor of IT infrastructure products and services, and its brands include Dell, Dell EMC, VMware, Boomi, Pivotal, RSA Security, Secureworks, and Virtustream . Although Dell Technologies has substantial exposure to commoditized markets and carries considerable financial leverage, we believe synergistic opportunities across its brands should make the company a key cog in businesses' hybrid cloud IT infrastructures.

Dell Technologies' largest revenue streams of commercial PC and servers are in cutthroat pricing environments that rely on services and support to generate profit. We expect the overall PC market to continue consolidating toward an oligopoly and for consumer-based profits to come from high-end and gaming PCs sales. While storage is a challenging marketplace, we believe flash-based arrays and hyperconverged infrastructure provide rampant growth avenues. We posit that the company's majority ownership of VMware and other cloud-centric software brands provide growth catalysts as firms augment hardware with software-based solutions.

After the acquisition of EMC, we view Dell Technologies as an end-to-end IT infrastructure provider that is supplementing hardware prowess with emerging software and cloud-based solutions. We're optimistic about its ability to upsell VMware and other cloud-based solutions, especially in high-growth areas of hyperconverged infrastructure and software-defined networking, but we do expect competitive markets to challenge the company's overall profitability.

We posit that Dell Technologies' debt burden may affect its ability to invest in the development and sales of future innovative products. Public shareholders have very little influence on the company's strategy and rely heavily on CEO Michael Dell and Silver Lake Partners making value-accretive decisions.

We project that Dell Technologies' revenue will rise at a five-year revenue CAGR of 5%. By product line, we project a 6% CAGR over the next five years for the ISG segment, which includes storage and servers. We model 6% storage growth in fiscal 2020 winding down toward 2% growth in fiscal 2023, primarily driven by flash array demand, data proliferation, and software-defined networking. We model a 2% CAGR for CSG, which includes PCs. We anticipate a strong Windows 10 refresh-cycle in fiscal 2019 but flattish revenue thereafter. We project VMware growing at a 10% CAGR as strong demand should continue for VMware's hybrid-cloud ecosystems and networking solutions, in addition to cross-selling opportunities. We expect the other businesses (Pivotal, Secureworks, RSA Security, Virtustream, and Boomi) to have a 17% revenue CAGR during the same time period due to cloud-based software adoption across IT teams.

In our view, Dell Technologies has ample room to lower its cost of goods after fully integrating EMC and Dell best practices while increasing product cross-sales and upsells, especially through adding software suites. We expect consolidated gross margin to increase towards 31% in fiscal 2023 versus 26% in fiscal 2018. In our view, Dell Technologies has substantial cross-selling and upselling opportunities as well as collaborative development efforts that will lower operating expenses as a percentage of revenue. In turn, we model operating margin to be above 5% of revenue in fiscal 2023 compared with negative 3.1% in fiscal 2018.