Dell may need that `float' as working capital drops

Technology stocks have fallen flat, but Dell Computer's shares still have fizz. They are down only 8.65 percent this year.

Investors seem to think Dell can prosper in even the worst tech downturn. So far, they have been right. In the quarter ended on Aug. 2, sales rose 11 percent from the period last year. At US$24.83, the stock trades at 31 times expected earnings.

But investors focusing on Dell's income statement should also weigh its balance sheet. It shows deterioration. A company's balance sheet indicates its ready cash. This is crucial now, given investor hostility toward the cash-poor.

Dell is decidedly not cash-poor. But if its balance sheet weakens, the company could lose one of its key advantages: the ability to strong-arm suppliers into waiting 37 days, on average,to be paid for their goods. Dell is paid by its customers instantly, so the company makes the most of this "float."

Working capital, a measure of liquidity, has declined markedly at Dell in recent years. It is used to finance production of goods before they are sold and consists of current assets minus current liabilities.

In 2000, the company's working capital was US$2.5 billion; in the August quarter, it was US$238 million.

The company said the decline was a result of its ability to stretch out payments to its suppliers.

Dell's liabilities are up 48 percent in two years, to US$9.5 billion; assets are up only 17 percent, to US$14 billion.

The biggest asset on Dell's balance sheet is US$4.6 billion in investments, up 69 percent from 2000. Except to state that holdings are managed to preserve principal, the company reveals nothing about the portfolio or its risks. The investments are carried at cost; unrealized gains and losses are charged against income only when a drop in value is determined by Dell to be "other than temporary."

Investors must trust Dell to value this asset properly.

Also troubling is the US$1 billion liability associated with Dell's previous sales of put options on its shares. It does not appear on its balance sheet but is disclosed in a footnote. The sales cover 22 million shares, with an average strike price of about US$48 a share. That means holders will get that amount for every put they return. With the stock at US$24.83, the options are very valuable.

Because Dell can meet the obligation by issuing US$1 billion of its own shares, it need not include the obligation on its balance sheet. But shareholders will pay somehow.

Dell's use of stock options has also cost the company. To offset dilution from options given to executives and employees, it repurchased 14 million shares for US$618 million in the August quarter. The average price per share was US$44, well above its current price.

Last year, Dell changed the way it accounts for buybacks. Before, their cost reduced retained earnings. Now it does not. So retained earnings, the earnings that were kept in the business, look far better.

In 2000, under the old accounting method, Dell posted retained earnings of US$1.26 billion. In the August quarter and under the new treatment, the figure was US$2.3 billion.

If the company accounted for buybacks as it once did, its retained earnings would have been wiped out. The figure would have been negative US$1.16 billion in the August quarter.

Dell said it changed accounting methods to make it easier for investors to see the shares bought back and at what cost. Instead of retiring shares, as previously done, they go into Dell's treasury stock account, so there is no impact on retained earnings.