's Rating Du Jour 12/3: Goldman Hearts Dell (DELL) on Deep Value, Pessimism and Michael Dell Put

December 3, 2012 12:14 PM EST
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Price: $13.86 --0%

Rating Summary:
    9 Buy, 21 Hold, 3 Sell

Rating Trend: = Flat

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    Up: 13 | Down: 22 | New: 54
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Join SI Premium – FREE's Rating Du Jour for December 3, 2012 is Goldman Sachs' bullish call on beaten-up PC-maker Dell (Nasdaq: DELL).

Goldman's Bill Shope raised his rating on Dell from Sell to Buy and raised his price target from $9 to $13, citing deep value amid the pessimism.

Shope notes that shares of Dell are down 31% since they assumed coverage with a Sell rating on December 12, 2010, versus a 14% gain in the S&P 500 during that time. YTD the stock is down 34%, versus a 13% gain for the S&P 500. Shares currently trade at 6X their CY2013 EPS estimate, which is 48% below the sector average multiple of 12X and 51% below the S&P 500. Also, Dell's net cash balance of $5.15 billion, or $3 per share, gives it an EV/EBITDA multiple of just 3X, which is 46% below their coverage average.

While the firm has urged investors to avoid "deep value" technology stocks, especially those with outsized exposure to the PC, server and printing end markets, the firm believes secular concerns have now become consensus. "With this in mind, we now believe that Dell has become an attractive deep value play and we would be buyers of the stock," the analyst states.

The firm cites three ideas to build a framework for deep value hardware: 1. Identify secular concerns that have become commonplace and potentially overdone; 2. Seek companies where downside risk to earnings expectations has narrowed; 3. Determine if cash flow and balance sheet stability provide strategic option value. While each of these factors in isolation can quickly lead investors into "value traps," names that meet all three criteria may very well be near a bottom and offer healthy upside from current levels. Dell fits into this framework, they say.

While Dell continues faces secular challenges owing to its exposure to PCs, the recent downdraft in PC demand has made the firm's long-held bear argument on PCs a consensus view. "Our forecast calls for roughly flat PC industry unit growth in 2013 (with aggressive pricing), though we believe most investors are now looking for a more severe unit decline. While this is possible, in our view it seems extreme and improbable," the analyst said.

Goldman's earnings estimates for Dell have been below consensus since they assumed coverage in December 2010. However, with the recent spate of downward revisions the downside risk to consensus expectations has narrowed. Goldman's current forecast for FY2014 calls for EPS of $1.53, which is just $0.13 below consensus and one of the narrowest differentials this year. "Though we still see downside to published consensus, our sense is that investors are already expecting earnings closer to our forecast, where we see the downside risk as being more limited," the analyst said.

In addition to secular concerns becoming too severe and consensus their lowest levels of the year, the analyst said the possibility of an LBO transaction or levered recap provides a floor for shares. "With Dell shares trading at such a discounted valuation, the company's sizeable cash position, and Michael Dell’s previous public comments about taking the company private, we built a model to help gauge the potential viability and attractiveness of a Dell LBO," the analyst said.

The firm's new 12-month target price of $13 is based on an EV/EBITDA multiple of 4X.

Shares of Dell are up 5.7% to $10.19 on the Goldman call.

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