The amount of rejiggering among the IT vendors serving enterprise customers (as distinct from hyperscalers, cloud builders, and HPC centers) in the past decade and a half has been astounding. And it is not yet clear what mix of products and services will yield long-term profitability for those who are playing the long game, and playing it big.
Hewlett Packard Enterprise and Dell Technologies, as they are now called, tried to build up IT conglomerates that, like IBM, had the four pillars of the IT budget – hardware, software, services, and financing. And then, when that didn’t work out, both companies decided to change strategies. HPE sold off its PC and printer business and backed away from hyperscaler and cloud system sakes, while Dell held onto its PC business, went private, and bought EMC and VMware to bolster its core IT business, and did a reverse merger with VMware to go public as 2018 came to a close. IBM started this all off by selling off its PC, high end printer, disk drive, and chip businesses and then sold off its System x X86 server business to concentrate on its Power Systems and System z platforms. IBM’s systems business is quite profitable, as we have revealed, but the company still struggles to build its public cloud and to make services make money even as they generate a huge amount of revenue.
HPE is smaller and not particularly profitable, as we showed in analyzing that company’s financials last week. Dell has become a lot larger than the remaining HPE, and has reached the same rough revenue level as Big Blue, although the companies have very different product and customer profiles. IBM has very much focused on large enterprises and HPC centers with some dabbling in hyperscale here and there with the Power platform. Dell still has a sizeable amount of revenue coming from PCs (both commercial and consumer buyers) and various IT gear that is sold to small and medium businesses. IBM has some SMB business, but that is mostly focused on its IBM i (formerly AS/400) midrange server business, which is part of the Power Systems division, which is now called the Cognitive Systems division to emphasize the fact that these machines are doing database, analytics, transaction processing, and other heavy work, not running basic infrastructure.
Dell completed its reverse merger with VMware, which it owned a majority stake in, back in December, which cost it $21 billion, of which $11 billion was paid in cash to outstanding VMware shareholders, and $10 billion was paid in Dell stock. This maneuver allowed Dell’s stock to appear on the New York Stock Exchange, where VMware was traded, for the first time since Dell went private in a $24 billion buyout six years ago. At the time, Michael Dell wanted the company that bears his name to go private so it could maneuver the business without the judgements of public shareholders and analysts on Wall Street. In the interim, with the buying of EMC and therefore its minion VMware, and then the reverse merger, Dell has spent a fortune reconfiguring itself and it has still not found its way to profitability. But the company is eating market share like crazy in servers and storage, and is holding its own in PCs, and is moving towards profitability ever so slowly.
Dell has so many moving parts over the past couple of years, with units and divisions coming and going, that it would be nearly impossible to get a consistent set of numbers to show how these aggregate businesses have done since the Great Recession, which is when a major inflection point was tipped in so many different parts of the economy and which is therefore a good starting point for analyzing any company in the current era. With the current data that Dell Technologies, the parent company, has made available since going private and buying EMC and VMware and divesting its services business, we can go back four years. (Note: Dell’s fiscal year ends in late January or early February, so the data is not presented on a calendar basis.)
Going private was clearly about buying time to create a much larger infrastructure behemoth while preserving volume discount leverage with Intel and other core component suppliers (think memory, disk, and flash) through keeping its PC business rather than selling it off or spinning it out. What is clear from the chart above is that Dell has become considerably larger over the past four years. In fiscal 2018 ended on February 2, Dell had grown revenues by 15 percent to $90.62 billion, with product sales up 18 percent to $71.29 billion and services sales (mostly break/fix stuff on the vast installed base of equipment it has sold, but also including subscriptions to software) rising only 3 percent to $19.33 billion. That is still an enormous services business, by the way. But IBM’s services business, as a whole, is about 2.5X larger. For that full fiscal 2018 year, Dell lost $2.31 billion, which was not as bad as the $3.35 billion in losses it had in fiscal 2018 but it was still larger than the $1.1 billion loss it had back in fiscal 2016 when it posted $51.17 billion in sales and the $1.67 billion loss it had in fiscal 2017 against $61.91 billion in sales. The point is, growth has come at the cost of profitability overall as a company.
But don’t get the wrong impression. The company’s core server, networking, and virtualization software businesses are profitable, at an operating level. It is servicing its enormous debt that is costing Dell so much money, and it is not a surprise to anyone that this is the case at this point.
It may be surprising that Dell has come back to the stock market before it was solidly profitable, but it wasn’t to ride its stock up as it squeezes more profits out of the business and continues to grow, and had it waited until it was done to emerge back on Wall Street, there would be no hero’s tale to tell as the fight was progressing. If Dell can achieve the synergies in its enterprise business, keep selling gear to some hyperscalers and cloud builders, and tend to its vast SMB fields, then there is every chance that Dell – the company and the man – could pay down its debts through profits and be free of all encumbrances.
Dell has been growing its PowerEdge server business for the past nine quarters and has four quarters of growth under its belt for its aggregate storage business, too. VMware, despite all of the challenges that it faces with the Microsoft Windows Server stack with Hyper-V and the Red Hat Enterprise Linux Stack with KVM, and not to mention all of the myriad ways to bring Docker containers and Kubernetes orchestration in to do away with virtual machines, is still very profitable indeed and is still growing.
Let’s go through some numbers, first for the fourth quarter and then for the full fiscal year to show you.
In the fourth quarter, Dell server and networking sales were up 14.8 percent to $5.25 billion. Server revenues were growing at a faster clip in the first three quarters of fiscal 2019, so it looks like Dell was feeling some pressure, but less than a lot of other players for sure. Storage sales rose by 9.4 percent to $4.64 billion. Add it up, and the Infrastructure Solutions Group at Dell nearly broke through the $10 billion barrier for the quarter, with sales up 12.2 percent to $9.89 billion. Operating income for Infrastructure Services Group rose by 69.1 percent to $1.27 billion, so this is all moving in the right direction.
In talking over the numbers with Wall Street, Jeff Clarke, vice chairman and the person in charge of products and operations at Dell, said that there was room for the company to grow its share of $85 billion datacenter infrastructure market, with about two thirds of that coming from mainstream servers and Dell only having about a third of the market. (We think that it is very tough to get even a third of a market with so many players in it, and am impressed that Dell has been able to take so much market share at all to become the dominant supplier of enterprise servers and storage in the world and still remain a player in the custom server racket.)
“We think there is room to grow there,” Clarke explained. “I think that is bolstered by the fact that we still see on-prem private cloud in an early build out. We talked on the previous call and throughout our series of roadshows, about repatriation of workloads, coming back to on-prem; we continue to see that. There has been some recent research by IDC that suggest there will be $120 billion spent on hardware for on-prem private clouds over the next four years and another $100 billion on software and services on top of that. We think that bodes well for the environment on a go-forward basis. And as is clear, we are in a multi cloud and hybrid cloud world.”
For the year, the Servers and Networking unit had $19.95 billion in sales, up 29.1 percent. Storage sales, across a wide variety of products that are being rationalized, organized, paired down, and focuses, rose by 9.6 percent in fiscal 2019, to $16.68 billion. For the full year, Infrastructure Solutions Group had an operating income of $4.15 billion, up 61 percent, so this is a huge improvement in profitability.
It wasn’t that long ago when Dell itself was only a $20 billion company aspiring to be a $60 billion company within a decade, and only three years ago, minus EMC, Dell’s infrastructure business was less than half its current size and its storage business was one-eighth its current size.
The VMware unit has been kept separate from servers for now as Dell is reporting its numbers, and its virtual server business (which runs on lot of iron from its competitors in the X86 server business) is only half the size of its physical server business. In the fourth quarter, VMware’s sales were up 13.2 percent to $2.64 billion, and its operating profit rose by 4.6 percent to $872 million, or about a third of revenues and by far the most profitable thing Dell has ever had its hands on. For the full fiscal year, VMware brought in $9.1 billion in sales, up 12.4 percent, and operating income rose by 6.3 percent to just a tad under $3 billion. VMware’s virtual server business might be half the size of the physical server business, but assuming that servers are as profitable as storage (maybe not a good assumption), the virtual servers are three times as profitable. In the quarter, bookings for NSX virtual networking were up by more than 50 percent, and bookings for vSAN virtual storage rose by over 60 percent.
Interestingly, the VMware Cloud on AWS inked its largest deal to date, for $20 million of services, to run the ESXi hypervisor, vSphere management tools, and a whole lot of cloud management tools on AWS iron for, we presume, a multi-year term. VxRail hyperconverged appliances have a $2 billion annual run rate, and so does the NSX virtual networking portfolio, which had $1.3 billion in bookings in fiscal 2019; it is not clear where vSAN is at in terms of bookings for the year or its annualized run rate as Dell exited the fourth quarter.
If you add up servers, storage, networking, and VMware, then Dell had sales of $45.81 billion, up 17.9 percent, and operating income of $7.14 billion, up 32.4 percent. In this case, the underlying profit is growing at twice the rate as the revenues, which is something IT vendors love to attain. The idea now is to grow the revenues and push Dell into an actual profit even though it has to pay down a lot of debts for the next couple to several to many years. (It is hard to say, especially if you look at its debt statements, which are a twisty turny story indeed.)
In the Others category, which includes sales of Pivotal, SecureWorks, RSA, Virtustream, and Boomi products, sales were up 5 percent to $593 million, which Dell does not think individually are large enough to call out separately. This Others category runs a moderate profit or loss in any given quarter and does not really affect the overall Dell company at this point.
If anything, Dell is a little more storage heavy than the industry at large, but it has all of the components of modern systems in its revenue streams, and on the volume platforms deployed in the market, unlike all of its peers.
Given this, Dell is perhaps the best reflection of core spending in the enterprise datacenter that we have. Its small and medium business customers, as Clarke pointed out, are the canaries in the coal mine. If they stop spending all of a sudden, that means large enterprise are likely going to follow. Even though growth in servers has slowed significantly, Dell and others are expecting for server purchasing to continue to be aggressive if growing more slowly than in the past five quarters. IBM used to be the bellwether, then it was HPE for a while when it was just called Hewlett Packard, and now it seems to be Dell Technologies.