Don’t Focus On Dell’s PC Business, The Real Story Is In Their ISG Division (NYSE:DELL)

Dell Technologies Inc. (NYSE:DELL) continues to remain a relatively cheap company, with the current valuation trading at 17x earnings, and according to analysts, the forward price-to-earnings are expected to be around 7x. This low valuation primarily stems from Dell’s core business i.e., PCs. The PC market has been absolutely hammered over the past year, with total sales down by 16%. Meanwhile, Dell was the hardest hit, with sales down 37%. This has led to the stock declining by 25%, for the year.

But there is a bright side to all of this for Dell, which is the ISG segment. The future of the ISG segment should help drive revenue resulting in, improved margins, cash flow, and in turn higher DELL stock prices.

Dell’s Business Is Taking A Turn For The Better

The key to Dell’s future is not its PC business, but rather what is known as the “Infrastructure Solutions Group.” For some reason, unknown to me, this part of the company is being completely overlooked by investors despite its relatively large potential. This as the stock has largely traded on news of the PC business, despite both the PC division and ISG division being largely on par in terms of revenue.

But before we explore the Infrastructure Solutions Group, there is also the factor of China reopening. The steep decline was due to a number of factors. One of those factors was China’s zero-COVID policy. This meant that enterprise buyers especially faced rather long lead times, and that led to declines that were steeper than expected. Enterprise sales are likely to pick back up in 2022, as built-up demand, and continued demand, i.e., demand regardless of the economic cycle, help mitigate the global slowdown:

“The Asia Pacific market (excluding Japan) declined 29.4% year-over-year, mainly due to the market in China. While the fourth quarter has traditionally a been peak season for China’s business PC market, budget cuts by the Chinese government and uncertainty around COVID policies led to a significant drop in overall PC demand, Gartner said.”

Expect both supply chains easing, and Chinese demand, to potentially even push PC sales in 2023 into slightly positive territory, as the effects of COVID wear off.

Beyond the China factor, there is another key pivot that has been happening for a while, and that is Dell’s cloud business and Infrastructure Solutions Group.

How The Infrastructure Services Group Is Changing The Landscape

The ISG segment currently accounts for around 40% of the current business, and revenue grew by around 12%, to $9 billion in 2022. Furthermore, the high growth is being combined with high margins, which should help the company drive profitability and cash flow in the future. Major clients include the likes of AMD and VMware. Both of whom have collaborated with Dell to provide ad-hoc service. The APEX offerings, which is a mix of cloud and hardware-as-a-service:

“Through the combined portal of its new Apex Console, customers can now purchase access to various types of storage, computing, and other hardware resources on either an as-needed, consumption-driven basis or a subscription basis.”

The multi-cloud, edge, and as-a-Service have taken on a number of big clients and should continue to see significant increases in client flow, and revenue in 2023. The mix of providing cloud and infrastructure services, supported by various major software backends, including VMware, will help the company drive revenue in the near future. The combination of infrastructure and as-a-service support could help drive the company’s ISG revenue at around 20% for the next half a decade. This will allow for enough opportunities for the company to provide the necessary infrastructure to everyone who potentially uses the as-a-service model, where the current market stands at around $220 billion, and could reach a total of $674 billion by 2028. Major industries, such as telecom, banking, financial services, and insurance, are all making a significant shift towards a cloud-based as-a-service model. Providing the necessary hardware and software support through a multi-cloud remains imperative. Meanwhile, the HaaS industry is expected to grow by around 26%, further adding impetus to the growth.

Competition is slowly getting fierce in the industry but will take time before it affects growth, and the capacity edge remains with Dell at the moment. There are others including Terraform and Puppet. It also has indirect competitors such as Amazon and Huawei, but the combination of hardware and cloud software offerings remains unique to Dell. HPE is another competitor, but again, in my opinion, Dell remains at the forefront, due to its collaborations and its ability to offer a range of end-to-end services including its latest security services, which should give it a slight edge over competitors, who offer fewer services.

Furthermore, the biggest market for HaaS remains North America, making up around 40% of the market. This gives another advantage to Dell, which can increasingly tap into the local market. Competitors, who might offer HaaS, may struggle to compete. On the other hand, the global market remains increasingly open for Dell. IBM has forayed slightly into hardware-as-a-service, but then has mostly given up, and does not pose any significant threat.

Final Overview

Investors have been largely focused on Dell’s PC business, but the ISG business segment has a significant ability to expand in terms of services, (services such as security, and other SaaS offerings), offered to complement its hardware as a service business. Therefore, they are potentially underestimating the company’s earnings potential. As the ISG group becomes a larger portion of the total revenue, cash flow will improve, due to the margin advantage, and therefore, the current valuation, where the forward P/E stands at around 7x earnings, makes the stock relatively cheap.

But risks remain, as global PC sales could continue to decline, which would further pressure on earnings, and could see the stock sell-off. But the combination of multiple tailwinds in 2023, including the China re-opening, may be able to overcome the current crop of issues, which makes the stock on a risk-reward basis, a buy, in my opinion.

Investors should continue to wait until the PC market becomes more steady before moving, and that offers an opportunity to enter the market. Dell Technologies Inc. is currently slightly flying under the radar. It remains to be seen where DELL stock heads over the next few quarters, but the long-term fundamentals are certainly intact.