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Dell's Return Boosts Investor Hopes, But Problems Remain

Michael Dell, Chairman & CEO, Dell
AP
Michael Dell, Chairman & CEO, Dell

Michael Dell returns to the daily grind at the company he founded more than 20 years ago. But a number of Wall Street analysts said the executive shake-up at the PC maker will be far from a quick fix because Dell is facing a number of fundamental problems.

Dell, who takes over as CEO for ousted Kevin Rollins, ends a four-year hiatus during which the company issued the largest consumer electronics recall ever, found itself the subject of a formal investigation by the U.S. Securities and Exchange Commission and lost its position as the world's largest PC maker to a rejuvenated Hewlett-Packard.

Ironically, Dell was one of the main beneficiaries of the 2002 merger of HP and Compaq since it removed a major competitor for corporate accounts and allowed Dell to expand sales as its presence in the enterprise market grew.

But in recent years, the company's share in the PC market began to crumble due to a glut of cheap PCs and weaker-than-anticipated sales of its pricier, more lucrative desktops and notebooks.

Weary investors cheered the move, announced late Wednesday, pushing Dell shares

up nearly 5% at Thursday's opening bell, but gains quickly eroded as Wall Street analysts offered a wide range of opinions on the return of the company's founder.

Stock Upgraded

Merrill Lynch upgraded the stock to "buy" from "neutral" and said the CEO shakeup indicates a new level of commitment to serious change at the company.

Analyst Richard Farmer told clients Thursday he believes the company will make aggressive moves to cut costs with improvements expected in the PC market as businesses upgrade to Windows Vista.

Farmer advised investors to be patient. "By the time investors are widely confident about improving prospects, the stock will have moved," he said.

In a statement yesterday, Michael Dell continued to emphasize the company's new strategy, "Dell 2.0," which focuses on customer service.

While the timing is uncertain, Goldman Sachs analyst Laura Conigliaro expressed confidence the company's founder can revive his company's profit margins.

Despite lack of clarity on the company's 2007 outlook, Conigliaro said the stock's turnaround potential is "too tempting" given easy year-ago comparisons for revenue growth and margins.

"We expect the stock to do very little in the next couple of months, bottom in the low $20s, and then start to gradually move higher based on anticipation of improving margins," she said.

Harry Blount, an analyst with Lehman Brothers, told CNBC's "Morning Call" that the next logical step for the company's "Dell 2.0" strategy is an increase in acquisitions. But with a number of competitors already on the prowl, quality companies will be hard to find, he said.

Plenty of Risks

"Dell will become an acquirer, but that is fraught with risks," said Blount. "The market is crowded by IBM and HP and Sun just got the investment from KKR, so there’s more buyers out there for fewer valuable tech properties."

For investors, the Lehman analyst said the current risks may outweigh the stock's potential.

"Michael is not a bad guy to bet on at all, but from a stock perspective, I think the risk to investors is that we're facing a value trap," said Blount. "On the downside you're protected by the free cash flow but on the upside, the company has to make a significant amount of investment in operating expenses, their customer care. So even if they gain share I'm not sure it translates to the bottom line."

Last August, Dell recalled 4.1 million potentially flammable notebook batteries made by Sony, the largest consumer electronics recall ever.

A.G. Edwards analyst David Wong also said the company's operational problems and accounting issues will take time.

"We think that Dell’s problems may take several quarters more to work through," the analyst wrote in a client note Thursday. "We do not believe that the changeover of CEO will result in a sudden improvement in sales performance."

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