Dell's valuation is inflated relative to its low-margin reality; expect multiple contraction and price decline.

Dell is less shiny since it doesn't build the chips or the AI models, but they do provide the infrastructure for it all, the data centers. So, it's not a pure play because half of their revenues comes from this legacy PC segment or at least that was the case in the past year.

But now it has shifted slightly and the infrastructure part of the business has actually grown to 60% primarily driven by 70% revenue growth in that segment year-over-year.

So as you mentioned there are two parts of this business. You have the legacy PC business and then you have the infrastructure business. And the PC business is quite mature and also commoditized with, you know, low margins of about 6 to 7%.

And the reason I pitch the Dell stock was because they started to get into these AI data center contracts. And those contracts went from essentially zero in the first half of 2024 to about $15 billion guided for the year with another $14 billion of backlog behind it.

And that guidance looked quite conservative even back then. So the investment case was you could buy a company for I think back then it was 12 times earnings that pays a high yield through dividends and buybacks and it might receive tens of billions of dollars in data center contracts for the months to come and that's essentially what has played out.

So the reason we didn't buy was that these data center contracts they come at low to mid single digit margins. So while volume is massive and will still drive profits through some operating leverage, the impact wouldn't be massive and most importantly I just didn't think it would be sustainable.

And I believe at least on that part we are right about it. I mean the gross margin continuously declined from 28% in 2020 to just 19% today. And we're not talking about the net margins. This is gross margins.

I would say we misjudged the market though. We thought the market wouldn't be too excited about that given the margin outlook, but apparently in the broader AI mania, that just doesn't matter all that much.

And so, as you said, the the sheer scale of the volume and and operating expense leverage still cause earnings per share and profits to grow substantially. And that is enough for the market today to assign a much higher multiple to Dell than just a year ago.

So the current forward PE is 22 times earnings and the average of the last 8 years is 8 and a half times. So pretty wide gap in that historical multiple versus today.

And so in one of the latest earnings calls, management actually said that the AI servers have mid singledigit operating margins, which is close to the assumptions you actually used in your model last year, Daniel.

So I I suspect Dell will have a hard time once we're on the other side of the massive data center builds and really what the market is doing is is being very forwardlooking. So all it takes is the pace of new data center construction to slow down and the market multiple will probably revert back toward its historical levels which for context its current PE is 30 times and so the median of the last 10 years again is just 10 times.

So, I can't help but think that we'll see his multiple contract and revert towards historical levels sooner or later and maybe perhaps sooner. It's not possible that it will go on for a while, but I certainly wouldn't like to bet on it either.

And in this case, it really does seem to me that the industry overall is sort of damned to be in the low margin position squeezed between companies like Nvidia and then all the data center clients which to some extent are also the hyperscalers.

what we could see to the downside then we can certainly also see to the upside in companies like Dell or actually the next company that we'll talk about which is Comfort Systems.

And it's kind of funny because both Dell and also Comfort Systems probably even more Dell they were pretty boring pitches. I still remember us sitting and discussing Dell and thinking gosh this is one of the least inspiring companies that we have yet looked at and now those are the companies that just completely crushed it.

And for a company like Dell, quite sure it will return to lower multiples and prices eventually.