October 5, 2000 2:25 PM PDT

Dell stock dips on profit warning, analyst downgrades

Dell Computer shares sank today to their lowest price in two years, in response to its revenue growth warning and subsequent analyst downgrades.

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PC sales: What next?
Roger Kay on Dell's warning
At the close of regular trading today, the stock was down $3, or 10 percent, to $25.19 on a volume of 116.6 million shares--nearly four times the average daily volume. Earlier in the day, the stock touched $25--its lowest price since October 1998.

However, the Round Rock, Texas-based PC maker escaped without a brutal sell-off like Apple Computer suffered. Last week, Apple plunged nearly 52 percent after issuing a more severe profit warning.

Dell delivered its revenue growth warning to financial and industry analysts yesterday at a conference in Austin, Texas.

Wall Street analysts took Dell to task. Bear Stearns this morning cut its share estimates on Dell but maintained its "neutral" rating. The financial analyst now forecasts 92 cents for this year, down from 94 cents, and cut 2002 estimates to $1.05 a share from $1.20. SG Cowen Securities' Richard Chu dropped Dell's rating to "buy" from "strong buy."

Walter Winnitzki at Chase Hambrecht & Quist downgraded Dell to "market perform" from "buy." Prudential Securities analyst Kimberly Alexy maintained her "strong buy" but cut Dell's 12-month price target to $43 from $68 per share.

And in a research note this morning, Merrill Lynch analyst Steven Fortuna maintained his "buy" rating on Dell but cut his third-quarter revenue forecast to $8.21 billion from $8.47 billion. He also slashed fourth-quarter revenue projections to $8.9 billion from $9.4 billion and shaved earnings-per-share estimates by a penny to 27 cents. Fortuna also cut sales growth projections for 2002 to 25 percent from 28 percent.

Dell, which will issue its third-quarter results Nov. 9, said revenue would grow only 7 percent from revenues of $7.67 billion for the second quarter. Historically, Dell's third-quarter revenue growth typically has been in the range of 10 percent to 13 percent.

Dell's downgrades today may stem as much from the second quarter's disappointing results followed by a slower-than-expected third quarter as from the profit warning.

Before the earnings alert yesterday, a consensus of analysts polled by First Call/Thomson Financial forecast earnings per share of 25 cents for its third quarter and 28 cents for its fourth quarter.

Dell also warned that fourth-quarter earnings could come in 1 cent to 2 cents below analysts' expectations.

Some analysts were blind-sided by the warning, which followed more optimistic guidance from Dell.

U.S. Bancorp Piper Jaffray analyst Ashok Kumar in early September warned of slowing PC demand going into the second half. At the time, a Dell representative put third-quarter growth close to 10 percent.

On Sept. 21, Dell CEO Michael Dell looked ahead to strong second-half growth for Dell and the PC industry. "The second half is usually stronger than the first half--certainly as an industry," he had said. "Demand is healthy."

If demand seemed strong, so too did component availability. "In terms of components, I think we're seeing something that we didn't quite to expect to see as an industry--that is, that the shortages aren't all they're cracked up to be," Dell said.

Dell's forecast may have been thrown off by a convergence of events: an unexpected drop in component prices during the last few weeks of September and the volatile nature of the third quarter.

Typically, about 40 percent of third-quarter purchases come in the last two weeks of September, according to analysts. This makes gauging results difficult before the very end of the quarter.

The drop in component prices benefited Dell in the short term but indicate larger, industrywide problems, say analysts.

"It looks to me like the supply picture has really turned literally around the last two or three weeks," said International Data Corp. analyst Roger Kay. "In other words, where we had been in a supply constraint all year, suddenly we're in balance."

There are two possible explanations for this, Kay said: Component makers may have overestimated demand, or PC sales are slowing as many people now expect.

IDC now is forecasting only 10 percent year-over-year growth for the worldwide PC market, but Kay warned that the growth could fall into the single digits.

Still, Dell's problems appear to be unique, with sales slower than expected in two areas: all business segments in Europe, and small and medium-sized businesses worldwide.

The sales slowdown hit Dell in some of its highest-margin products, such as servers, application servers and Web hosting services.

"We've seen a significant drop-off in the kind of dot-com arena which had exploded on the scene in Q4 and Q1," Dell told financial analysts yesterday. While this hurt sales, he said, "we're still seeing that small-business sector growing in excess of 30 percent."

IDC's Kay seconded the significance for Dell of the hard times that have affected many young Internet businesses. "It looks like the dot-com melt that we saw earlier in the year is going to come through later in the year," he said.

Slower sales in Europe also hurt Dell, as they hurt Intel, which issued a profit warning about two weeks ago.

While the euro's performance against the dollar dented sales, Dell is dealing with other issues as it expands its European operations.

"What we've been trying to do is establish a firm foundation before we kind of launch our European team," Dell vice chairman Kevin Rollins told financial analysts yesterday. But the company has been dealing with "a number of factors that we had to fix internally," he said.

 

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