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Dell Set to Ride Approaching IT Replacement Cycle

December 30th, 2009 Michael McDonough

Back in October I mentioned I had a rather bullish view on the tech sector going into 2010, but the only name I mentioned at the time was Apple (APPL).  Recently, I’ve been speaking with quite a few money managers and one name in the sector has been coming up more than most others, and that’s Dell (DELL).  Looking ahead to 2010, low capital costs for businesses combined with increasing confidence will likely lead to increments in business investment and spending on equipment and software.  Investors have already seen hints of this with a 1.5% seasonally adjusted annualized increment in 3Q09 equipment and software investment.  This is likely only the tip of the iceberg, and Dell is well positioned to take advantage of the approaching IT replacement cycle.

Dell 1Y Performance

Dell 1Y Performance

Source: Google Finance

Dell has faced some downward pricing pressure over the last several months after a disappointing 3Q09 earnings report.  However, part of this slack could have been due to the late October release of Windows 7, which likely caused consumers to postpone PC purchases until the 4th quarter.  Additionally, I believe a number of analysts are underestimating the probability and the magnitude of an IT replacement cycle in 2010, giving the stock more upside potential once the cycle materializes.  Roughly 25% of Dell’s revenues are derived from the company’s commercial PC hardware segment, with another 11% coming from server equipment; both segments are poised to benefit from an IT replacement cycle.  According to Dell, PC’s currently installed are on average 9 to 12 months older than the historical average, which should add some fuel to the approaching cycle.

Additionally, as you can see from the chart below, since November Dell has significantly underperformed the NASDAQ’s Computer Index, and I believe it is only a matter of time before Dell begins playing catch-up.  The managers I spoke with fervently believe the stock should be valued somewhere between $20 and $24, and have indicated to me that they have put their money where their mouths are.  The downside risk is of course that the IT replacement cycle does not materialize or is weaker than expectations.

Dell vs. NASDAQ Computer Index

Dell vs. NASDAQ Computer IndexSource: Yahoo Finance

List of my Equity Based Global Macro Investment Ideas:

Trading IdeasSource: Bloomberg

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