Summary We expect value stocks to outperform the S&P 500. #DVMT is a tracking stock of @VMware. VMware is a top quality stock that is not incredibly cheap, but DVMT’s discount versus VMware makes DVMT good value for money. Earnings and price momentum is positive. Time for value? I’m not telling something new when I say that the US stock market is not cheap. The numbers in Exhibit 1 speak for themselves. Exhibit 1: Worldwide valuations  This leaves US equity investors two options: Invest in foreign stocks and/or Invest in US value stocks. According to Franklin Templeton, there's a strong historical relationship between value and non-US equities. Over the past two decades, non-US stocks have tended to outperform US stocks when value starts to work. Today, we talk about a neglected US value stock: @DellTechnologies (NYSE:DVMT). @DellEMC, @VMware and a tracking stock The site @VisualCapitalist recently posted a visual about the Early Business Pursuits of Bezos, Buffett, and Other Legends. One of those other legends was @MichaelDell, the founder of Dell Computer Corporation. Exhibit 2: the Early Business Pursuits of Michael Dell  In 2013, Michael Dell, with the help of @SilverLakePartners, took Dell private in a leveraged buyout. On October 12, 2015, Dell announced its intent to acquire the enterprise software and storage company EMC Corporation (including its 81% participation in VMware (NYSE: VMW)). As part of the deal, EMC shareholders received $24.05 in cash and 0.111 shares of a newly issued tracking stock: Dell Technologies Inc. - V Share Class. The tracking stock is a class of common stock ("Class V") issued by the parent company (Dell Technologies) of Dell and EMC. The tracking stock is intended to track the performance of a portion of Dell Technologies’ economic interest in the VMware business. Exhibit 3: Economic interest in VMware  Tracking stock discount Tracking stocks have been utilized many times in the past, including by such blue chip companies as The Walt Disney Company (NYSE:DIS), General Motors (NYSE:GM), Liberty Media (NASDAQ:FWONA), AT&T (NYSE:T) and Georgia Pacific, and most recently by Fidelity National Financial, Inc. (NYSE:FNF) in June 2014. While not as common as certain other financing structures, tracking stocks are not a new structure. Advertisement  Tracking stocks, which are designed to reflect the performance of another company, invariably trade at a discount to the real stock, mostly because they don’t offer direct economic ownership of the underlying company. DVMT also carries higher risk than VMware’s ordinary shares because it has been issued by Dell’s parent company, Dell Technologies, the highly-leveraged private vehicle used to mount the EMC-acquisition. Exhibit 4 clearly shows that the discount rose in the weeks after the listing because EMC investors who received the stock for the Dell acquisition sold their shares. Unlike EMC, VMware does not pay a dividend, forcing some fund investors to sell to meet their internal rules. After this initial selling, the discount narrowed, and on Friday October 13th, the discount closed at 29%, slightly below the average of 31%. Exhibit 4: DVMT-discount  We expect this discount to narrow further in the future and to disappear completely in a few years. There are three possible triggers for this discount reduction. Dell is generating a lot of free cash flow and is deleveraging rapidly. Since closing the EMC transaction, Dell paid down approximately $9.5 billion of debt. This makes DVMT less risky. Dell is buying back DVMT shares. Dell repurchased approximately 19.7 million shares of DVMT and is planning to further repurchase up to $300 million. Implicitly, Dell is saying they think the discount is too big (and that things are going well at VMware). Note that VMware is itself also buying back shares. A spinoff of Dell’s VMware stake to tracker holders in a one-for-one share swap would eliminate the tracker/VMware discount. Such a move isn’t likely for four years because of adverse tax consequences, according to New York tax expert Robert Willens. This last option might look like wishful thinking, but only recently there was a similar move that eliminated the tracker discount. John Malone’s Liberty Interactive (NASDAQ:QVCA) announced a complex deal that would help eliminate its “tracking stock” structure. We do expect that the discount will eventually disappear. VMware, a modern Pick-And-Shovel Play EMC’s 81% participation in VMware was one of the reasons Dell wanted to take over EMC. VMware is a global leader in cloud infrastructure and business mobility. It calls itself the pioneer in virtualization and an innovator in cloud and business mobility. VMware allows companies to run, manage, connect and secure applications across clouds and devices in a common operating environment. You could call it a modern Pick-And-Shovel Play. During the California gold rush, many of those who earned money did so by providing the miners with picks, shovels and other equipment needed for gold mining. VMware is certainly earning money (and creating free cash flows). For the fourth year in a row, IDC named VMware as the global market leader in both cloud systems management and datacenter automation. VMware also advanced its position as a visionary in the July 2017 Gartner Magic Quadrant for datacenter networking. Exhibit 5: Gartner’s Magic Quadrant for Data Center Networking  Money is not an issue VMware is generating lots of free cash flow. It expects for the fiscal year that ends in January 2018 a free cash flow of $2.74 billion (compared to an enterprise value of $39.6 billion). VMware’s financial health is reflected in its Altman Z-score of 4.92. The Altman Z-score gives an indication of financial health (or distress). It uses profitability, leverage, liquidity, solvency and activity to predict whether a company has a high degree of probability of being insolvent. A score below 1.8 means the company is probably headed for bankruptcy, while companies with scores above 3 are not likely to go bankrupt. The Piotroski-score for VMware stands at 9, which is the highest possible score. The Piotroski-score is a financial score between 0-9 which reflects nine criteria used to determine the strength of a firm's financial position. This score helps to identify the best value stocks. Scores 7-9 are the best and 0-3 are the worst. VMware has more than $5 billion in net cash on the balance sheet. This is more than $13 cash per share! This leaves ample room to return capital to shareholders in the form of share repurchases. VMware has currently $900 million remaining on its existing $1.2 billion repurchase authorization which extends through the end of fiscal 2018. The VMware Board recently authorized an incremental $1 billion in repurchases through the end of August 18. In addition to this expected open market repurchase activity, VMware recently agreed to repurchase $300 million of class A common stock from Dell Technologies. Earnings momentum Reuters’ revisions summary clearly indicates that the earnings momentum is positive! Exhibit 6: Earnings revisions  Exhibit 7: Consensus earnings  Valuation Based on expected earnings per share of $5.54, VMware trades at a forward-looking PE of 20.9. Not really cheap but quite close to the S&P 500 average of 20.6. When we take DVMT’s current discount of 29% into account, you can buy – through DVMT - a healthy company with strong financial metrics at a PE of 14.8! Now we are talking about value! Implicitly, we are assuming that the discount will disappear. But this is exactly what we are expecting to happen! Price momentum On the graph of both VMware and DVMT, we can clearly see that the momentum is positive. Exhibit 8: VMware price chart  Exhibit 9: DVMT price chart  Conclusion  The combination of: a declining DVMT discount, a reasonable VMware valuation, VMware’s quality characteristics, rising earnings estimates, and positive price momentum... ...should reward investors: buy the Dell Technologies tracking stock! This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
https://seekingalpha.com/article/4114399-dell-technologies-adds-value-vmwares-quality-momentum
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