It’s hard to get excited about mature markets growing at a steady rate unless it’s the most profitable part of the market. And with regard to the global IT market, the share of it that is consumed by enterprises – that is, anything smaller than a hyperscaler and a large cloud builder or outside of an HPC center or telecom/service provider and in this case including government agencies and educational institutions – is by far the most cost effective.
It’s also a notoriously proactive company in the face of economic downturns and cautious in the face of economic rebounds, reflecting the conservative nature of the world’s 20,000 largest companies and the millions of other companies that supply them or try to compete with them.
With that in mind, we view IT vendor Dell, which among the major OEMs is one of the few that still sells data center hardware and customer hardware. (Lenovo does too, but not Hewlett Packard Enterprise, Inspur, Cisco Systems and others.)
As part of its financial results for its third quarter of fiscal 2023 ending in October, Dell’s top brass characterized the total addressable market that Dell is pursuing, then even offered a forecast for the TAM data center through 2025. That data was, to be frank, some of the most interesting stuff Dell talked about because we don’t often get such insight from major IT vendors. Also interesting is how Dell manages its data center business in these strange times of turbulent economy and fragile supply chains, and what Dell’s infrastructure customers are spending. how the business is performing given all the uncertainties.
The thing to never forget is that IT organizations have to spend. Budgets never fall to zero and things still need to be done, even if no one is in the mood to be extravagant. Dell was definitely not in the October quarter.
Chuck Witten, who is co-chief operating officer with Jeff Clarke at the company, said on a conference call with Wall Street analysts reviewing the numbers that Dell has indeed seen demand for infrastructure, but added a caveat that storage sales “held up.” doing quite well compared to servers, with growth in several storage types, including high-end and PowerStore.
Witten added that with its direct selling model, Dell has immediate feedback from IT customers across all geographies and industry sectors and can see the demand environment change faster than the rest of the industry. , and given this, Dell tightened the purse strings and reduced operating costs by 3% sequentially in the second quarter of the fiscal year and an additional 6% in the third quarter of the fiscal year, reducing costs by $300 million and contributing to the profitability of its Infrastructure Services Group and Client Services Group. Dell has also been able, Witten said, to capitalize on lower component costs faster than its peers and therefore increase profitability. This assumes that Dell did not pass the cost savings on to customers, and given the backlogs for server, storage and networking products, we believe that Dell did not have to pass on these cost savings. costs on components in the form of price reductions. Witten also said Dell was able to reduce its server backlog, which has grown steadily throughout the pandemic due to component supply issues. Ultimately, Dell expects to increase its market share (based on data coming out of IDC next month) in servers and storage.
And it’s the patient game Dell has played to become the most dominant OEM on the planet, far surpassing HPE, Inspur and Lenovo and well ahead of Cisco Systems and a weakened Big Blue since it divested its System x X86 server. in 2014. Dell continues to win new customers and new business, using its volume component buying power across the client and server supply chains to extract what meager profits it can from the IT industry.
That’s not much in terms of earnings for Dell, especially a year after the VMware split:
In the third quarter, Dell’s overall product sales fell 12.1% to $18.94 billion and its services sales fell 15.6% to $5.78 billion. Overall revenue fell 12.9% to $24.72 billion, and its net income was reduced by 93.6% to $245 million, but that was against a very tough comparison as some profits on the VMware spin-outs were recorded last year. Since then, Dell’s profits have fallen faster than its revenue, and you can attribute much of that to PCs, not servers, storage and switching.
Dell reduced its debt by divesting from VMware – it is down 43% to $27.33 billion – but the sharp tightening in the PC market and the slowdown in the data center infrastructure market caused Dell to burn silver, which is down 73.4% year-over-year to $6.44 billion.
Due to improved component supply and lower component prices, Dell’s Infrastructure Services Group – which manufactures and sells servers, storage and switching – achieved a business of $9.63 billion, up 12.4%, and had an operating profit of $1.37 billion, which is 14.3% of revenue and increased by 53.7%.
Within ISG, server and networking hardware sales rose 14% to $5.2 billion and storage sales rose 10.6% to $4.43 billion. In general, Witten said the T3 was about the same as the T2 in terms of customer sentiment and attitude. The drop in sales in China was steeper than expected, but spending by the energy sector, the US federal government and midsize businesses in general exceeded overall spending by all Dell customers.
“Client feedback is very similar to what we described in the second quarter, a very cautious and deliberate behavior in the face of a lot of macro dynamics,” Witten explained. “So we’re hearing a reassessment of budgets, a reprioritization of spending, and customers effectively buying for their immediate needs.”
And so, the demand for new servers was lower than expected, Dell filled much of its backlog and now says the server backlog is now at what it calls normal levels. And with a more predictable supply chain, it has side effects that increase profitability because freight can be consolidated and shipped in volume and the expedited shipping rate is much lower, which helps group profitability. ‘infrastructure. As Clarke said, “because supply is ahead of demand, we’re able to put things on the ocean and we don’t have to speed up so much” with air cargo.
Where there are constraints are in server power supplies, power supply ICs and high-performance network cards, according to Clarke. For storage, custom ASICs and FPGAs are limited. But the Dell factory PC part is within standard lead times – a demand crash will do that! – and the server part of the factory is mostly within standard timelines – because a slowdown in server sales will do.
Looking ahead, Dell expects ISG sales to be flat sequentially – meaning they will be up around 4.5% year-over-year – and CSG sales to be down at mid-20s 20% year over year, which equates to about a 5.5% sequential decline. Considering the current economy and the fact that people don’t want to spend on PCs because they’ve just done so in droves during the pandemic, that’s about as good as the biggest OEM in the world can get expect it.
Surfing the rising TAM
Since fiscal 2020, Dell has grown its PowerEdge and APEX server business by a compound annual growth rate of 3%, and over the past five years it has gained 5.3 points of revenue market share in the consumer server segment, according to IDC data cited by Writing.
Looking ahead, Dell believes it can achieve compound annual growth of 3-4% (likely through FY2025), which while lower than the 8% CAGR it had between FY2020 and FY2025. fiscal year 2023, continues to grow at the pace of the IT market. growth in general in the sectors where Dell plays.
Here is the total addressable market that Dell has pursued during the 2021 calendar, broken down by segments:
There was a $720 billion TAM for 2021 in the major IT and data center hardware companies that Dell researches, which Dell expects to grow at a CAGR of 2% between 2021 and 2025. There is another TAM of $720 billion in adjacent markets where it is beginning to play, such as in infrastructure as a service (APEX utility-priced machines), technology outsourcing, data management and system infrastructure software.
Yes, we know what you’re thinking: Didn’t Dell sell all that stuff? With this second $720 billion TAM having a 10% CAGR, Dell can’t afford not to pursue it. It remains to be seen how it will do this and to what extent it will do so.
With around $38 billion in sales for ISG in 2022, Dell is expected to get a roughly 20% share of the $189 billion in server, storage and TAM switching in the data center in 2022. If it maintains just his share until 2025 he will have a $44.5 billion ISG business. This would be a CAGR of 5.4% for ISG between 2022 and 2025 (calendar years). And if it can grow its share by 1 point per year – as it has – it would be a $51.2 billion ISG business with a CAGR of 10.4% over the same period.
These are, in our view, the brackets between which Dell’s ISG will fall. But these are just numbers. It will take a lot of work to make that happen, and a recession – a real, prolonged recession, not just the defibrillator shock we get from the Fed – will throw this model into the trash.
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