After visiting the management, Morgan Stanley concluded: No need to worry about Dell!

Driven by the trend of large-scale model competitions, server manufacturers have also become followers of NVIDIA in the field of artificial intelligence. In the overnight market, the darling of artificial intelligence, Dell, surged by 5% once again. Year to date, the stock has accumulated a rise of about 90%.

Morgan Stanley analysts, including Erik W Woodring, recently visited Dell's headquarters in Round Rock, Texas, and met with Dell's management. Following this meeting, analysts pointed out in their report that Dell has outstanding engineering capabilities in the field of artificial intelligence servers. Due to the technical complexity of this field, Dell is expected to be one of the few winners among server manufacturers, with its revenue and profitability further enhanced. Analysts also believe that Dell's stock price has been suppressed due to its average performance in the first quarter and the reduction of holdings by major shareholders, making it a good time to buy on dips.

High Technical Threshold in AI Server Market, Strong Engineering Capabilities of Dell, Leading Order Share

Analysts pointed out that contrary to common beliefs, engineering capabilities and technological differentiation are driving Dell's market share growth in the artificial intelligence server market.

The firm emphasized that the design, construction, and innovation of artificial intelligence servers are much more complex than what investors understand. This is why Dell not only gains market share in the artificial intelligence server market, but also defends/expands its market share in traditional server manufacturing. Other companies cannot compete with Dell in terms of their ability to provide end-to-end solutions (including integration, design, deployment, optimization, and support services):

In discussions with management and key computing engineers, we were able to better understand the complexity of creating the most compact server form factor, leading storage density, the most PCIe ports, liquid cooling capabilities, and the complexity of customizing and optimizing computing, networking, and storage from servers to rack-scale.

Our research shows that technological differentiation has played a role in helping Dell win recent orders for secondary CSPs, sovereign states, and enterprise artificial intelligence servers.

Our visit to Dell's headquarters has given us more confidence that, given what we have seen/learned from an engineering/technical perspective, Dell will continue to be one of the few major winners in this rapidly growing market.

According to management, Dell is currently involved in almost all opportunities for building artificial intelligence infrastructure for secondary CSPs and sovereign states, with most transactions involving the construction of large-scale accelerated computing training clusters. In terms of cloud service facility construction (Cloud Service Providers, CSPs), demand remains very strong and is likely to accelerate in 2025:

According to management, Dell's bidding rate in large sovereign states should be similar to that of the secondary CSP market, where the bidding rate is very high and increasing this year. Demand for enterprise artificial intelligence servers may follow closely behind sovereign states, although Dell already has hundreds of enterprise artificial intelligence server customers. In summary, this indicates strong demand for artificial intelligence servers in the second half of this year and in 2025

Over time, the profit margin of AI servers will increase

Some comments suggest that Dell's AI server business profit was weak in the last quarter. However, Morgan Stanley believes that over time, the profit margin of AI servers will increase:

We believe that Dell's AI server gross margin is comparable to other major manufacturers, and management has reiterated that Dell is not a price aggressor in this market, with pricing averaging 10% higher than original equipment manufacturers.

At the same time, almost all CSP and enterprise AI server transactions signed by Dell include a layer of high-profit (40%) and sticky services, which will be deferred and amortized over time (we believe service fees account for 10% or less of the total system price). Importantly, management points out that currently deferred AI server service revenue exceeds amortization, which means that with the gradual decrease in the amortization schedule of transactions, under other equal conditions, AI server revenue and gross margin should increase.

If we also consider the shift towards sovereign countries and enterprises (much better profit margins) in the business mix, as well as the expansion of the business scale, we will find that over time, the profit margin of AI servers will increase, contrary to the current consensus expectations.

Storage and PC business expected to rebound next year

Regarding storage and PC businesses outside of AI, analysts commented that Dell's storage hardware profit margin is low, dragging down the performance of the ISG department in the last quarter. However, the end market is currently recovering, and Dell has recently launched a series of new storage products to regain a competitive advantage:

We believe Dell has laid the foundation for turning around the storage business, as the actual end market seems to have matured and can recover growth this year, with even greater growth by 2025 (FY26).

Most importantly, Dell recently launched 1) PowerStorePrime to address the lost market share in the mid-market, including a new 4.0 all-flash array platform, new software upgrades (which can increase IOPS by 30%, reduce latency by 20%, and double storage capacity), new QLCAFA arrays, and new data protection software; and 2) ProjectLightning to address AI computing attached storage opportunities, including the new PowerScale all-flash file storage optimized for AI (F910) and a new parallel file system.

For the PC business, analysts believe that the launch of Microsoft AI PCs can drive a wave of PC industry upgrades, especially in the enterprise sector:

The PC market will continue to benefit from enterprise refresh cycles. Indeed, our time spent on CSG business discussions with management is limited, but the expectation for low single-digit revenue growth this year remains unchanged, even though industry analysts have slightly lowered their forecasts for PC unit growth in the past 3 months

Given Dell's high relevance to the commercial market, we believe it will be one of the major beneficiaries of enterprise PC upgrades later this year and into next year (including Windows EOL upgrades). Due to the rising input costs caused by inflation, the profit margin of CSG in fiscal year 25 may decrease year-on-year