Technology

Return to Article

Woe Is Dell

Alexei Oreskovic

Perhaps Dell(DELL Quote) CEO Kevin Rollins behaved badly in a past life.

His company is clearly suffering from some bad karma.

For those keeping score, Dell said Thursday that federal regulators were looking at its books. The news came a few days after Dell announced the largest recall of a consumer-electronics product ever, which came after Dell's warning a few weeks earlier that it would miss its financial targets for the second quarter.

That warning came a few months after a similar warning Dell issued for the previous quarter.

The barrage of bad news was enough to make some throw in the towel -- at least for now.

"Dell's current headwinds seem severe enough, if only for a few quarters, to rattle even those who were convinced that Dell shares already discounted virtually all of its issues," wrote Goldman Sachs analyst Laura Conigliaro in a note downgrading Dell from a neutral rating to a Sell rating. (Goldman Sachs makes a market in Dell shares and has received compensation for providing Dell with investment banking and non-investment banking services in the past year.)

Dell shares slid 5%, or $1.14, to $21.66 in midday trading Friday.

Management's contention that a turnaround was in progress and would soon show results did little to allay investor skepticism.

And the latest legal twist involving an informal SEC investigation into Dell's revenue recognition added to the uncertainty surrounding the computer maker.

During a postclose conference call Thursday, Dell's management downplayed the importance of the investigation, describing it as almost routine.

"We received an informal letter from the SEC, one of, I think, hundreds that they send out each year, asking a fairly broad level of questions, on revenue recognition at our end-of-quarter procedures," said Rollins.

SEC representative John Nestor would not comment on the Dell investigation.

He said that the SEC brings about 600 cases a year in which the commission actually sues a company for securities-law violations, although he would not comment on how many investigations regarding revenue recognition are initiated every year.

While all investigations are handled by the agency's enforcement division, Nestor said that a formal investigation authorizes the SEC to issue subpoenas.

An informal investigation "is just an affirmation by the commission directing the enforcement division to devote the necessary time and resources to determine whether violations have occurred or not," said Nestor.

The SEC has the full range of civil remedies available to it, said Nestor, including fines and penalties. If the SEC sues a company and settles, frequently a restatement will be part of the settlement terms.

Dell has said that it doesn't believe the issues under investigation will have a material impact on its previously reported results, although it has opened its own internal investigation into certain matters it discovered while responding to the SEC.

While Dell could end up paying a fine of a couple million dollars, one investor said he doesn't think the investigation indicates a big Enron-esque fraud case.

"I think all companies ought to be investigated periodically just to let them know that the cops are around," says Legend Financial Advisors President Louis Stanasolovich, whose firm doesn't have a position in Dell.

But while he may not be spooked by the investigation, Stanasolovich doesn't see any reason to buy Dell shares at the moment, given the various challenges facing the company.

One of those challenges involves Dell's ongoing struggle to find the right balance between sales growth and margins.

Dell blamed some of its margin pressure in the second quarter to component costs which didn't come down as much as the company expected.

Deutsche Bank analyst Chris Whitmore, however, says that Dell's description of component costs are contrary to what companies like Hewlett-Packard(HPQ Quote), Seagate(STX Quote) and Western Digital(WDC Quote) have reported. What's more, with Intel(INTC Quote) and Advanced Micro Devices(AMD Quote) engaged in a price war, microprocessor prices have been declining.

The real culprit for Dell's increased component costs, contends Whitmore, was its decision to two-time Intel after using Intel processors exclusively for years.

"Although management would not comment on its relationship with Intel, we believe Dell likely lost significant 'co-marketing' dollars from Intel this quarter, either as a result of Dell's decision to start using AMD processors, or resulting from AMD's lawsuit against Intel," said Whitmore, whose firm makes a market in Dell shares and has provided Dell with noninvestment banking services in the past year.

It's hard to say exactly how much of an impact Intel's co-marketing dollars have on Dell, with Intel declining to comment on its customers' financial results.

Of course, co-marketing dollars or not, switching from one chip supplier to two would likely increase Dell's costs since it's manufacturing operations now need to build separate product lines.

In the long run, however, Dell believes that it will see cost savings by benefiting from the fierce competition between Intel and AMD.

It might even change Dell's luck.