Dell Is a Leader in PCs. How a Spinoff Could Unlock the Value in the Stock.

Now, Dell Technologies (ticker: DELL) is about to become much more attractive to investors as it prepares to spin off its valuable stake in software maker VMware (VMW) in early November.

Dell will emerge with a solid balance sheet and simpler structure. This will allow investors to get direct exposure to one of the world’s top technology hardware makers at a bargain price. With annual sales of more than $90 billion, it is a leader in personal computers, servers, and storage devices.

“The VMware transaction should unlock some of the value in Dell,” says Simon Leopold, an analyst at Raymond James. “It creates a more simplified narrative and an easier-to-understand story.”

Shares of Dell have recently traded around $106, but roughly half that price is attributed to Dell’s 81% interest in VMware, When Dell completes the spinoff, shareholders should get roughly $55 a share in VMware stock—assuming that the software company remains near its recent price of $152—leaving them with a “core Dell” valued at about $51.

Core Dell, which should have a market value of nearly $40 billion, is where much of the opportunity lies. The stock effectively trades for just eight times projected earnings of about $6 a share for the company’s fiscal year ending in January. (The consensus Dell estimate of $9 a share now includes its share of VMware earnings.)

Samik Chatterjee, an analyst at J.P. Morgan, says the low “valuation could be a catalyst for Dell.” He says that it has a better outlook than rivals HP Inc. (HPQ) and Hewlett-Packard Enterprises (HPE), which have similar price/earnings ratios.

And Dell trades for half the P/E multiple of Cisco Systems (CSCO), which has a comparable profit growth outlook. Chatterjee has an Overweight rating on the stock and a price target of $67 on core Dell.

In September, Dell unveiled targets of annual sales growth of 3% to 4% for the next four years and 6%-plus yearly growth in earnings per share. That is far from spectacular, but comparable to what food and electric utilities are generating, and they trade for double Dell’s implied multiple.

Chatterjee views Dell’s guidance as conservative, and he sees high-single digit annual growth in earnings. He projects “core” earning of $6.09 a share in the current year ending in January (what Dell calls fiscal-year 2022) and $6.55 next year. His view is that Dell can trade for 10 times earnings—hardly a rich valuation at half of the market multiple.

Investors can wait until the VMware spinoff to consider buying Dell or purchase the stock now and either hold or sell the VMware shares that they will receive in the spinoff. Dell has not yet set a date for the spinoff.

Dell holders will get about 0.44 share of VMware per Dell share. The estimated spinoff value of about $55 for every Dell share is determined by multiplying 0.44 times an adjusted price of $125 a share on VMware. That is VMware’s recent share price of $152, less a roughly $27-a-share dividend that VMware will pay to its holders and directly to Dell, not to Dell holders.

VMware is much cheaper than subscription software stocks like Salesforce.com (CRM). It trades for about 21 times projected current-year earnings, but is growing more slowly and faces more challenges as businesses move their computing needs to the cloud.

Dell’s recent results have been strong, buoyed by a robust market for PCs. Revenue was up 15% in its quarter ending in July, and adjusted earnings rose 17%. It has two main divisions: the client solutions group (PCs) and infrastructure solutions group (servers and storage).

One question about Dell’s prospects involves the health of the PC sector, which received a big lift from people working at home during the pandemic. “We see another leg up on the commercial side, even as the consumer business moderates,” says Chatterjee of J.P. Morgan. Dell is the industry leader in higher-end PCs geared toward corporate buyers.

Dell’s gross core debt, excluding the obligations of its finance unit, should fall to about $20 billion after the VMware spinoff. Dell’s net debt (debt less cash) could end 2021 close to $5 billion, and it has long sought investment-grade credit ratings from two major agencies.

This will enable the company to initiate a roughly $1 billion annual dividend in its fiscal year beginning in February for yield of about 2.5%, based on the current, implied price of core Dell.

That could attract income-oriented funds. It also has unveiled a $5 billion share repurchase program. Chatterjee projects about $2 billion in annual buybacks.

A buyback would shrink a relatively small public float of about 38% of its roughly 765 million shares outstanding. CEO Michael Dell controls about 50%, and investment firm Silver Lake, which participated in the 2013 buyout, owns 12%.

Then there is the Michael Dell factor. Many shareholders—and Barron’s—criticized him over the Dell LBO and then when Dell bought out holders in a Dell tracking stock for VMware in 2018. That deal allowed Dell to go public.

One issue now is that Dell has a dual-class structure: Michael Dell owns supervoting stock with 10 votes a share. Some investors would like to see Dell move to a single class of one-vote stock the way VMware will be doing after the spinoff.

“And why is it necessary, if ultimately you control the majority of economic interest, to have such a structure in place?” Toni Sacconaghi, a Bernstein analyst, asked the Dell CEO earlier this year.

(Dell executives declined to comment for this article.)

Getting rid of that structure would enable Dell to be included in the S&P 500 index, which doesn’t admit companies with dual classes. Michael Dell has rejected the idea, saying that he has “no plans” to collapse the share classes.

That is a mild negative. More important, the interest of investors is now aligned with Michael Dell in an underrated and inexpensively valued company.

Write to Andrew Bary at [email protected]