Dell (DELL) reported terrible first-quarter results Tuesday that revealed just how difficult the firm’s transition to serve the enterprise market will be, particularly as its consumer business faces pressure from Apple’s (AAPL) iPad and other tablets. We are putting our fair value estimate for Dell under review, and we expect to lower it materially. And while we maintain our view that the firm’s shares are significantly underpriced at today’s levels, we prefer Apple in the market-beating portfolio of our Best Ideas Newsletter.
The computer maker’s revenue declined 4% from the same period a year ago as sales to small-and-medium businesses did little to offset the rapid decline in its consumer business, where revenue fell 12%, and in its large enterprise segment, where revenue dropped 3%. Non-GAAP operating income fell 27% from last year’s quarter as research & development expenses swelled by 20%, while non-GAAP earnings per share came in at $0.43 per share, 22% lower than the mark achieved in the year-ago quarter. Consensus estimates were at $0.46 per share, so it was quite the miss.
The company’s headline earnings number would have been even worse were it not for aggressive share buybacks. If it hadn’t been active on the market buying back its stock (Dell shrunk its share base by 8% on a year-over-year basis), reported diluted earnings per share would have been $0.33, a very poor showing. Because we think Dell’s fair value is above its current market price, the share buybacks are actually value-creative for shareholders, but perhaps a more prudent use of capital at this time may be to allocate it to operating initiatives to turn the company around. And to top off the terrible quarterly performance, Dell’s cash flow from operations swung from a source of cash to a use of cash, with the company losing $138 million in cash from operations during the period. First-quarter free cash flow was a negative $280 million and compares to a positive $328 million from the same period a year ago.
Looking ahead, the company expects revenue to advance just 2%-4% sequentially in the current quarter from the most recently-reported period. The outlook indicates, however, that on a year-over-year basis, sales will fall about 4%-6%. And while consensus estimates had suggested a year-over-year sales decline was a likely outcome, the magnitude of the decline was unexpected. Investors should anticipate Dell to adjust its fiscal 2013 earnings outlook lower in August. The weak outlook is consistent with what we’ve seen from other tech giants, namely Cisco (CSCO), which a couple weeks ago, offered a poor outlook that sent shutters through the networking space. We plan to update our report on Dell shortly.