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Dell Dashes Momentum

Alexei Oreskovic

Like a patient with a mysterious illness, Dell(DELL Quote) continues to surprise investors with unexpected and unpleasant changes in its condition.

The latest episode came in a dramatic fashion, as the PC maker delayed its third-quarter earnings release and conference call at the 11th hour and noted that government regulators have stepped up their investigation into its accounting practices.

The news caught Wall Street by surprise and sent Dell's shares down 4.1%, or $1.06, to $24.69 in recent trading Thursday.

The developments create more uncertainty for the Round Rock, Texas, company, which was supposed to deliver third-quarter financial results Thursday without the baggage of a negative preannouncement that has accompanied its previous two quarters' results.

Thrivent Financial's Mike Binger bemoaned the fact that the news comes just as it appeared Dell was starting to get its act together.

"All the feedback from the channel is that their business is improving off the bottom," says Binger, whose firm is long Dell.

Binger says he has no idea how important the Securities and Exchange Commission investigation will prove, given Dell's limited and cryptic statements about the probe to date. At the very least, however, it's a distraction on the PC maker's road to improvement, he says.

In a note to investors, Goldman Sachs analyst Laura Conigliaro offered a much more cynical interpretation of the latest events.

"We see this announcement as potentially part of a larger picture involving Dell's internal controls," wrote Conigliaro. The accounting issues in the investigation are the latest in a string of recent examples of ineffective controls in Dell's business, including "unnecessarily aggressive pricing, badly chosen go-to-market strategies and poor customer service-related decisions."

She said the government probe and the earnings delay could precipitate management changes. Goldman Sachs makes a market in Dell and has provided the company with investment and non-investment banking services in the past 12 months.

In an announcement late Wednesday, Dell said that the SEC has ordered a formal order of investigation into the company. In the past, Dell executives have characterized the SEC's contact with Dell as consisting of an "informal letter," asking a "fairly broad level of questions."

At the most basic level, the government's escalation of the probe from informal to formal status means it now can wield subpoenas.

This could indicate any number of things, says Michael Perlis, a former assistant director of the SEC's enforcement division who is now a partner at the Stroock & Stroock & Lavan law firm. The SEC may be having trouble getting Dell officials to voluntarily cooperate in the investigation, or there may be third parties related to the matter that cannot -- or will not -- participate, he says.

Or, it could be that based on its preliminary review, the SEC has found issues it wants to explore further.

Whatever the case, though, says Perlis, it is not a positive sign for Dell.

He noted that formal investigations can take anywhere from several weeks to several years, and that the menu of remedies available to the SEC range from levying fines and seeking restatements to barring people from serving as officers or directors.

An SEC spokesperson told TheStreet.com earlier this year that the commission sues about 600 companies a year for securities law violations.

What the investigation actually involves is not entirely clear, and Dell has not gone out of its way to clarify things.

In a statement about the probe earlier this year, Dell said it involves the "possibility of misstatements in prior period financial reports, including issues relating to accruals, reserves and other balance sheet items that may affect the company's previously reported financial results."

Analysts took turns speculating about the nature of the mysterious probe Thursday in a slew of notes to investors.

American Technology Research analyst Shaw Wu posited that it could relate to Dell's treatment and accounting of marketing rebates from Intel(INTC Quote) and its product warranties.

Richard Gardner of Citigroup reckoned that any enforcement actions stemming from the investigation were likely to be minor, given the relatively limited potential for abuse in Dell's direct sales business model.

"This model makes for relatively straightforward accounting and less reliance on management estimates than competitors build-to-forecast, channel fulfillment models," wrote Gardner. "Moreover, we have not seen the significant divergence between earnings and cash flow that often signals a company's attempt to boost reported earnings in the face of an underlying deterioration in fundamentals."

Gardner, who rates Dell buy, said he did not believe the delay reflects a shortfall in Dell's third-quarter results, and reiterated his estimate that Dell will beat Wall Street EPS estimates by a couple of cents.

An officer at Citigroup is a director at Dell; Citigroup makes a market in Dell shares and has provided Dell with investment and non-investment banking services in the past 12 months.

But with Dell's decision Wednesday to eventually release its third-quarter results only as a press release, without the customary conference call, as well as the continuing postponement of its annual analyst day briefing, it's getting harder and harder to figure out what's ailing Dell and how to ascertain a prognosis.