What's wrong with Dell?

Investors sent the company's stock down 8.28 percent Tuesday

Dell Inc.'s run as the financial darling of the technology world may have come to an end Monday as the company announced it would miss its quarterly revenue target for the second straight period. The company blamed a shortfall in its U.S. consumer business and its U.K. operations, but competition around the world and a changing market may also be dragging Dell back down to earth.

Investors punished Dell on Tuesday, sending the company's stock (DELL) down $2.64, or 8.28 percent, to close at $29.24 on the Nasdaq Stock Exchange. They were reacting to a press release issued by Dell after the close of trading on Monday in which the company outlined its expectations that third-quarter revenue would fall short of earlier targets. At the same time, Dell disclosed plans to take a $450 million charge to cover the expected costs of replacing faulty capacitors in its OptiPlex desktops, a write-down of excess inventory, and layoffs in its Texas and U.K. operations.

Three financial analyst firms -- Moors & Cabot Inc., The Bear Stearns Cos. Inc., and UBS Securities LLC -- downgraded their ratings for Dell on Tuesday. In a report Tuesday, Moors & Cabot analyst Cindy Shaw cited "growing concerns" about Dell's performance in many different sectors of its business.

"We have previously expressed concerns about Dell's competitive position in servers, upselling challenges and customer satisfaction. To this list we now add: a stall in PC unit share gains in 3CQ05 (according to Gartner), concerns Dell has not handled recent product failures well ... and another quarter of decelerating revenue growth," Shaw wrote in a report distributed Tuesday.

Dell has made its mark in the technology industry by growing at phenomenal rates even amid the rubble of the dot-com bust in the early part of this decade. The company's famous dedication to inventory management, build-to-order products, and aggressive cost-cutting has allowed it to become the worldwide leader in PC shipments and a considerable source of pain for traditional server vendors such as Hewlett-Packard Co. (HP), IBM Corp., and Sun Microsystems Inc.

In 2002, Dell set a goal of reaching $60 billion in revenue by its 2007 fiscal year, which would have doubled the company's yearly revenue at the time. In February of this year, Chief Executive Officer Kevin Rollins said the company would reach that goal in its 2006 fiscal year, which ends this coming January, and set a new goal of $80 billion in revenue by 2008 or 2009.

But the company now appears unlikely to hit $60 billion in revenue this year. Assuming it takes in $13.9 billion in the third quarter, the number it cited in its press release Monday, Dell will have brought in $40.7 billion in revenue during the first three quarters of its 2006 fiscal year.

Even though the last few months of the calendar year are considered the best period for PC and server sales, Dell will have to take in $20 billion during the quarter to hit Rollins' goal. That would be a 49 percent increase over quarterly revenue in the same period last year.

Next week, Rollins is expected to shed a little more light during the company's earnings call on the factors that are plaguing Dell this year, but analysts already have their own ideas. Even though Dell cited slowdowns in its U.S and U.K. businesses as problems areas, Dell could also be missing out on accelerating growth in parts of the world where it does not dominate the market, analysts said.

HP has a stronger presence in Europe than does Dell, and Dell is under significant pressure from Lenovo Group Ltd. in Asia, Shaw wrote in her report. Dell had been gaining share in some of these markets but appears to have given back some business in the most recent quarter, according to Roger Kay, president of Endpoint Technologies Associates Inc.

Dell's market share in the Asia-Pacific region, for example, declined in the third quarter compared to the second quarter, while its competitors all gained market share during the same interval, according to IDC. The company's unit shipments grew strongly compared to the previous year, but there are questions about how well Dell's direct model will work in rural areas of Asia-Pacific where people are used to buying products in local retail establishments, Kay said. Right now, Dell is focusing on large cities in China and ceding the fast-growing rural areas to companies such as Lenovo and HP, he said.

Dell has also been hit with a customer backlash over declines in product quality. Numerous Web logs dedicated to highlighting problems with Dell products have appeared this year, and the company's customer approval rating plunged in a survey conducted by the University of Michigan.

The situation with the OptiPlex desktops will not help that reputation. Faulty capacitors on the motherboards of certain OptiPlex desktops can fail over time with no real warning, a Dell spokesman said Monday. The company does not plan to recall the units, but it will replace the motherboards of any units that fail, he said.

On the server end of Dell's business, several converging trends such as virtualization, blade servers and sophisticated server management software are presenting new challenges for a company that is used to selling servers as commodities, said Gordon Haff, principal analyst with Illuminata Inc. in Nashua, New Hampshire.

"Dell has had a really good run selling essentially cookie-cutter rack-mount servers," Haff said. "But the era of solving problems by just buying more boxes is coming to a close."

Dell has sought to change its image this year, starting with its April analyst meeting, in which it gave press and analyst attendees many details about its growing services and printer businesses but said little about PCs and servers. The company urged financial analysts to look at more pieces of Dell's business than just its PC and server sales in order to get a true picture of the company's health, perhaps foreshadowing the current situation.

Monday's announcement produced more questions than answers about Dell's current situation, and Kay hopes Rollins will have more to say next week. "Dell should err on the side of fuller disclosure here, rather than just blaming the most obvious visible issues for the shortfall," he said.

Copyright © 2005 IDG Communications, Inc.

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