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The Bizarre Story of Data Transmission Just Got More Bizarre

Herb Greenberg

The Thursday Thud:

A year ago, at the urging of hedge fund manager Peter Kamin, who owned more than 5% of the company, it hired an investment banker with the intention of finding a buyer. Kamin became chairman of the committee that looked into ways to get the stock higher, including the sale of the company. The stock reacted by leaping to as high as 46.

Short-sellers, in turn, started betting that the company's basic biz model was flawed because much of Data Transmission's offerings could increasingly be had for free on the Internet.

Fast forward to last week: The company said after considerable thought it had given up trying to find a buyer because nobody wanted to pay what the company thought it was worth. Besides, it said it has embarked on a new Internet strategy. The stock, already in a swan dive, slipped as low as 17. (Kind of ironic to see a stock go down on news of an Internet strategy.)

Which brings us to late yesterday: The company said its CEO had quit, and that Kamin, the hedge fund manager, was the new chairman and -- get this -- he'll once again head up the same committee he headed up before to hire an investment banker and seek ways to get the stock higher, including the sale of the company.

Gee, I feel like I just rented a bad movie, again.

The researcher is Tom Chanos of Badger Consultants in Madison, Wis., who has been quoted here in the past on Data Transmission (yep, the same wacky one in the above saga.) Like most Dell shorts, he acknowledges that Dell is a fine company that has done an excellent job executing its strategy. "The problem is that a lot of people are looking in the rearview mirror," he says. "I'm looking at future growth."

His key points include:

• A dramatic slowdown in revenue growth. "The law of large numbers is starting to catch up with Dell," Chanos says. He's estimating that Dell's first-quarter revs will be close to $5.35 billion. That translates into a 36.5% year-over-year gain, its lowest in at least three years. "For any company this would be good growth," he says. "However, Dell used to grow revenue year after year in the 50% to over 60% range." Worse yet, he adds, "the direction is down and it appears to us that it will continue to go down."

• A dramatic slowdown in earnings growth. Hasn't happened yet, but with more competitors entering Dell's space, Chanos believes margins could come under pressure. His first-quarter EPS of 15 cents per share would translate into a negative 3.2% sequentially. Chanos says that would be Dell's worst showing in 13 quarters. It would also be a 36.4% year-over-year gain, the lowest in three years and half the rate of six months ago. "If earnings are going to grow at half the rates in the past then surely the P/E ratio could fall in half as well," he says.

• A slick slide in selling prices, especially sub-$1,000 machines. "These machines are flying off the shelves, and they're putting enormous downward pressure on average selling prices," Chanos says. He figures Dell would have to do $7.7 billion in revs by the fourth quarter just to reach a growth rate of 50%. "That is more than they did in all of 1997," he says. "With ASPs falling every quarter, Dell has to increase its unit sales by 50% year over year every quarter just to get 35% revenue growth. At some point soon, they will not make it."

If he's right, Chanos thinks Dell could slip to 25 in six to 12 months. It closed yesterday at 38 1/2.

Dell won't discuss valuations, but a Dell spokesman says the only reason the company's revenue fell was because the company was too conservative in its bidding. "In retrospect, our net margin was too high," he says, adding that the company could have been more aggressive going into the fourth quarter when bidding for business. "Had we been more aggressive, in retrospect, we could've driven more top-line growth."

He also reiterated earlier statements that Dell will quit adding personnel and building its infrastructure at the same pace its revenues are growing.

What about earnings coming under pressure as other PC makers switch to the Dell-direct model? The spokesman says Dell currently sells fewer than one system out of 10 sold worldwide, and that Dell's competitors are still mostly doing business the old-fashioned way. "Even if you allow that others are making their business models more efficient, to suggest they're encroaching on Dell is to suggest that Dell is stagnant and that's a foolhardy suggestion."

As for the law of size catching up to Dell, the spokesman says a company exec recently addressed that very issue and agreed that at some point that'll happen, "but when? You don't see $12 billion companies growing at 50%, but we did."

Finally, on the issue of falling prices, the spokesman says sub-$1,000 is no longer the low-end of the market. "And we have said we won't play in the low- end until we figure out how to do it appropriately for our investors ... we won't go into any space without making appropriate returns for our investors."

The rest will be history.