Thumbs Up for Dell, Down for Microsoft

Michael Dell opened the inaugural Dell World 2011 information-technology conference in Austin on October 12. One of the topics�of conversation at the convention is Dell�s (NASDAQ:DELL) declaration that it is focusing its tablet business on Microsoft�s (NASDAQ:MSFT) Windows 8 rather than Google�s (NASDAQ:GOOG) Android platform. Despite the close working relationship between Microsoft and Dell, though, things aren�t perfect. Apparently, Dell has cancelled plans for any new Windows Phone devices until 2012, and possibly beyond. What this means for the stocks is anyone�s guess, but it does make a good segue into the topic for this article, which is that investors should sell Microsoft and buy Dell. Here�s why.

Missed Opportunities

Microsoft is notoriously slow to make decisions and possibly even slower to admit mistakes and change course. Take the Windows Phone, for example. Most people could have predicted as late as five years ago that smart phones would rule the world, yet the new operating system Microsoft unveiled to replace its antiquated Windows Mobile platform didn�t appear in the U.S. until November 2010, a year later than originally intended. Late to the ball, its market share continues to wither away.

Apple (NASDAQ:AAPL), Research In Motion (NASDAQ:RIMM) and Android have all taken the chairs at the table, and Michael Dell likely sees the writing on the wall before Microsoft does. Estimates suggest that Microsoft sold as few as 1.4 million units�last quarter — fewer than the number of preorders for the iPhone 4S over one weekend. Given Microsoft�s resistance to change, it is going to move ahead by merging the PC and mobile interfaces and hope for the best. We all know how this story will end. Badly.

Another example is Microsoft�s Kinect, the $150 motion-tracking device for its Xbox console. Microsoft spent hundreds of millions developing it and now it�s selling like hotcakes. The original plan was to sell the Kinect cheap as a way to generate further game sales. Unfortunately, what company didn�t anticipate was the hackers�who repurposed the Kinect for all kinds of uses, including attaching it to a Roomba, iRobot�s vacuum cleaner, so the robot can be directed around a room with hand gestures. The list of alternative uses for Kinect is a long one. Microsoft, in its infinite wisdom, refuses to welcome the creative exploitation of its product, staying silent on the matter. Instead of welcoming the open-source community as Apple did with the App Store, Microsoft chooses to sulk when it really needs embrace creativity. Is it any wonder younger people don�t take Microsoft seriously?

Too Much Cash

Microsoft�s decision�in 2008 to take on debt hasn�t changed the company one bit. In fact, it�s probably made things worse. You see, when it made that decision, it had $23.7 billion in cash. Today, that�s up to $52.8 billion, or $6.14 a share. That�s 75% of its revenue per share. It has so much cash that it is once again considering acquiring Yahoo (NASDAQ:YHOO). That�s a huge mistake at any price. In 2008, Yahoo rejected Microsoft�s $44.6 billion offer as too low. Today, Yahoo�s market cap is around $20 billion.

Having too much cash has Microsoft chasing deals that make little sense strategically or financially. Let someone else overpay. The answer for Microsoft is obvious. It is a technology company. It should spend its money acquiring technology companies such as iRobot, where at least there�s a fit with its existing products. This abundance of cash will continue to haunt it.

Free Cash Flow

One of the concerns some investors have with Dell is its rising level of debt. Its total debt as of Feb. 1, 2008, was $587 million, and as of July 29, $7.7 billion. Its debt-to-capital ratio has gone from 13.6% in 2008 to 48.1% in 2011. Investors should be aware of this increase, but with a little examination one will see that its use of debt has been prudent. For instance, in the first six months of 2011, Dell�s noncurrent long-term debt increased 25% year-over-year, to $6.4 billion. In the same period, its cash flow from operations increased 80%, providing plenty of cash for capital expenditures and three acquisitions totaling $2 billion, including the purchase of its Canadian financial services arm.

Since February 2008, Dell has made 12 acquisitions for a total of $6.5 billion. Of those acquisitions, by far the biggest was its $3.9 billion deal for Perot Systems in November 2009. The purchase of Perot Systems doubled Dell�s cash flow overnight and it should finish fiscal 2012 with free cash flow of $4 billion or higher, and a free cash flow yield of 20%. That�s very healthy indeed. It�s clear its movement to higher-margin products is slowly paying off. Buy now, while its stock is reasonably cheap. It won�t be on sale forever.