Why Dell Is the Latest Big AI Acquisition (NYSE:DELL)

The race to freeze the artificial intelligence (AI) market is on. Hyperscalers like Alphabet (GOOG) (GOOGL), Meta (META), Amazon (AMZN), Microsoft (MSFT) and Elon Musk’s xAI are spending billions as companies around the world use generative artificial intelligence, robotic process automation and machine learning to improve efficiency in a hyper-competitive business world.

Musk believes AI will make a giant leap from generative (creating content or performing tasks using massive pools of data) to artificial generic intelligence (AGI) within two years, while others predict it will take longer. Whether you think Musk is right or wildly optimistic, cheering him on or horrifying him (or whatever) is beside the point.

The idea for investors is to find companies that benefit from huge spending. This is why I recently started a post in della TECHNOLOGY (NYSE:DELL).

Ask for tailwinds

Statistics predict global data center revenues will increase by 50% in five years, from $416 billion this year to $624 billion in 2029, server and storage sales alone grow from $176 billion to $308 billion. This is a huge opportunity for Dell.

Much of this will come from hubs built by “Hyperscalers” such as those mentioned above. Dell is a major supplier to the xAI initiative that aims to build the “world’s largest supercomputer” and will provide server racks. You can read more about it here. A key competitor, Super Micro Computer (SMCI), is also involved in this build, and its problems could put Dell in the driver’s seat. Success here will translate into future contracts.

Super Micro Computer’s woes are positive for Dell. Super Micro’s stock tumbled as it delayed its annual 10-K filing and its reputation suffered after a scathing short report by Hindenburg Research.

It doesn’t matter if the report is an eye-opener or a hatchet job. After these events, would you rather be a salesperson for Dell or SMCI?

NVIDIA ( NVDA ) and Dell are also well integrated with the Dell AI Factory and Project Helix, aimed at accelerating the adoption of AI technology.

These strong partners will enable Dell to rapidly expand its market share.

Impressive results

Dell’s fiscal second quarter results are encouraging. Revenue grew 9% year-over-year (YOY) and 13% sequentially, as shown below.

Operating income and free cash flow were also strong at $1.3 billion each. But the best news is in the details.

Infrastructure Solutions Group (ISG) sales (which serve its data center customers) reached $11.6 billion, up 33% year-over-year, supported by an 80% increase in server and networking revenue, as as shown below.

The increases are a direct result of increased market demand. Here’s a selection of CEO Jeffrey Clarke’s comments, my emphasis:

In ISG, orders and shipments for our AI servers increased sequentially again. Our unique ability to deliver industry-leading air- and liquid-cooled AI servers, networking and storage… continues to resonate with customers. Order demand was $3.2 billion, driven primarily by Tier 2 cloud service providers. Encouragingly, we continue to see growth in number of enterprise customers purchasing AI solutions every quarter.

Enterprise remains a significant opportunity for us as many are still in the early stages of AI adoption… We shipped $3.1 billion of AI servers in Q2… AI server backlog remains healthy at $3.8 billion.

Most excitingly, our AI server pipeline expanded to both Tier 2 CSPs and Enterprise customers again in Q2 and it has now grown to several multiples of our backlog.

The robust market, its industry expertise and the struggles of competitors are a great setup for Dell. But there are other considerations.

What could go wrong?

All stocks have risks, and Dell is no exception. The industry is competitive and the highly cyclical PC market is the biggest business. Some predict a new upgrade cycle driven by the operating system and AI-related performance updates, but that’s speculative at this point. Consumers are clearly feeling the high interest rates; however, rate cuts are expected soon.

Is Dell stock a buy?

In addition to the massive potential of its ISG group, Dell shareholders have other advantages. The dividend yields 1.5% after healthy 20% growth this year, and management’s goal is to grow it by at least 10% annually through fiscal 2028. This will give investors today a return of at least 2 % at cost, regardless of share price increases.

The company is more prolific in share buybacks, with $700 million in the most recent quarter and $3.6 billion, or 4.5% of its current market capitalization over the past twelve months. As shown below, the number of shares outstanding shrinks rapidly as buybacks increase.

Dell can do this because of its prolific free cash flow, which was $24 billion over the past five years and $1.3 billion last quarter — a run rate of $5.2 billion.

The stock trades at a higher price-to-earnings (P/E) ratio than its recent averages and peers like HP ( HPQ ), as shown below.

However, Dell’s recent results have been more impressive and analysts are bullish, with an average price target north of $150 per share, or 32% above the current price. Additionally, Dell could beat analysts’ earnings-per-share (EPS) estimates if it gains market share due to Super Micro’s problems or if demand is even stronger than anticipated.

Many stocks have already caught the AI ​​train at the station, but Dell is still trading at a reasonable valuation and up 36% from its most recent level. This is why I initiated a position when the stock fell to $100 per share and I still consider the stock a strong long-term buy.