PCs Continue to Bring Down Dell

 Dell reported disappointing first-quarter results, as the firm struggled to deal with weak demand in Europe and stiff headwinds facing the PC market. At this point, we don't expect to change our fair value estimate, but if our outlook for the PC market deteriorates, we will consider a modest adjustment downward. We were already modeling a gradual decay in the firm's operating margin, but if results continue to deteriorate on an accelerated basis, we will make the necessary adjustments to our forecast.

Total revenue of $14.4 billion was down 4%. This is below our expectations, and nearly 6% below management's forecast from the previous quarter. PCs were a key source of weakness, with PC revenue down 6% year over year as Dell struggled against aggressive pricing in emerging markets, and weak demand as tablets become a more popular substitute. There's little evidence yet to suggest that ultrabooks are an effective weapon for Dell against tablets, and now the firm is holding up its upcoming line of Windows 8 tablets to stem the damage. We remain skeptical. Within PCs, laptop sales were the hardest-hit, down 10% from the first quarter of fiscal 2012. Dell's gross margin of 21.3% reflects continued struggles, with PC pricing more than offsetting the benefit from a product mix-shift  to enterprise solutions.

There were few bright spots from the quarter, but the results from enterprise technologies and services were less disappointing than those from the client technologies. Services, servers, networking, and storage combined to deliver 2% growth year over year. This was also below our expectations, but we remain confident in Dell's strategy to own the IP (instead of reselling), and we see greater stability in the long-term demand for these enterprise focused solutions.

Looking ahead, Dell is projecting sequential growth of 2% to 4% which, at the low end, would imply a year-over-year revenue decline of 6%. We expect greater visibility surrounding the firm's outlook during the analyst day in June.

Despite the challenging quarter, the transition from client technologies to enterprise hardware and services remains under way. Enterprise solutions and services now deliver 50% of Dell's gross profit, despite accounting for just 31% of revenue. We believe this transition will leave Dell in a much stronger position than if it had remained focused on reselling other firms' intellectual property in PCs. Nonetheless, the transition will continue to take time and money. Meanwhile, the challenges of operating a PC business will continue to take a toll on Dell's overall operating results. 

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