For Dell, a $24.4 billion (Dh89.5 billion) deal to take itself private is a bold move out of Wall Street’s spotlight as it tries to remake itself in a world where personal computers are no longer the big business in technology.
Yet the buyout — which was announced Tuesday and would be the biggest by far since the days of the recession — is a huge gamble. It will saddle Dell with $15 billion of new debt, and it does nothing to divert the forces reshaping the technology industry and undercutting the company’s business.
Fifteen years ago, Dell made enormous profits from selling customised PCs directly to customers. Six years ago, it was the world’s leading maker of personal computers. Today, it is in third place, behind Hewlett-Packard and Lenovo, and falling.
Dell’s share of an already contracting market for PCs slipped to 10.7 per cent last year, from 16.6 per cent six years earlier.
No-name rivals from Taiwan and China grind earnings to razor-thin margins. Android smartphones and iPads, not Windows laptops and desktops, are the best-selling and most moneymaking devices.
And while a shift to cloud computing has increased demand for data centres — an opportunity for Dell to sell servers — big customers like Google and Facebook build their own equipment cheaply. The rise of cloud services has also prompted many companies to forgo buying additional machines, instead relying on rented time and applications running on faraway computer networks.
Dell’s share of the market for servers slipped about 1 percentage point, to 22.2 per cent of 9.5 million servers sold in 2011. The greater problem in this segment is the pressure on profit margins. Shaw Wu, an analyst with Sterne Agee, estimates operating margins on servers, once about 15 per cent, are now “in the high single digits, compared with the mid-single digits for PCs.”
It is likely that servers will soon have PC-like margins, he said.
Michael S. Dell is betting his stake in the company and some $700 million of his fortune that he can meet those challenges and turn around a business he started in 1984 in his dormitory room at the University of Texas.
“Dell’s transformation is well under way, but we recognise it will still take more time, investment and patience,” Dell wrote in a memo to employees Tuesday. “I believe that we are better served with partners who will provide long-term support to help Dell innovate and accelerate the company’s transformation strategy.”
Dell’s investment means he will maintain control of the company if its shareholders approve the deal. The private equity firm Silver Lake, one of the most prominent investors in technology companies, is contributing about $1 billion in cash.
And Microsoft, seeking to shore up one of its most important business partners, has agreed to lend Dell $2 billion. Microsoft itself is under pressure, with longtime suppliers flirting with rivals to its Windows operating system.
“Microsoft is committed to the long term success of the entire PC ecosystem and invests heavily in a variety of ways to build that ecosystem for the future,” the software giant said in a statement.
Despite taking on an additional $15 billion in debt, Dell and Silver Lake argue that the company will survive, thanks to the cash that the PC business still generates.
A.M. Sacconaghi, an analyst with Bernstein Research, estimated that the amount of debt Dell will pay is less than what it has spent in stock dividends and share repurchases.
“This debt load is manageable,” he said, “as long as the cash flow from PCs holds up.”
Potential further declines
People involved in the transaction said that the buyers had prepared for potential further declines in the PC business but intend on at least maintaining the company’s position. Dell’s cash from operations has held steady for four of the past five years, coming in at $5.5 billion for the most recent fiscal year.
The size of the transaction evoked the frothy deal-making days before the financial crisis. Dell would be the biggest buyout since the Blackstone Group’s $26 billion takeover of Hilton Hotels in 2007. Yet few expect a resurgence in giant leveraged buyouts. While the continued availability of cheap financing makes such deals possible, financiers caution that Dell represents a special case because of the founder’s big equity stake.
The deal is the biggest test yet for Dell, 47, who has a fortune estimated at $16 billion. After a three-year absence, he returned as chief executive of the company in 2007, vowing to restore his creation. His strategy has focused on moving into the business of data centres and corporate software services, marked by numerous acquisitions that have cost billions of dollars.
So far, that has yielded little. Dell’s shares have fallen 31 per cent over the past five years, closing Tuesday at $13.42 — below the buyout’s offer price of $13.65.
But that strategy will largely remain in place if the management buyout is completed. The company will cut its PC offerings further and buy more companies involved in corporate computing for small and medium-size businesses, said Brian T. Gladden, Dell’s chief financial officer.
Although Dell has bemoaned his company’s dismal stock performance for years, his plan to take it private began in earnest only last year. The billionaire maintains a home in Hawaii near the residences of two prominent private equity executives, Egon Durban of Silver Lake and George R. Roberts of Kohlberg Kravis Roberts, and began floating the idea of a deal with them, people briefed on the matter said.
By August, Dell formally approached the board with a proposal to take the company private, prompting directors to form a special committee to study alternatives to a deal, these people said. One priority was keeping the process devoid of conflicts of interest to head off potential legal challenges, including the hiring of JPMorgan Chase to provide advice and Evercore Partners to solicit other suitors.
The committee considered ways to keep the company public, including borrowing money to buy back shares, but concluded that the management buyout was the most attractive option.
Dell had aligned himself with Silver Lake, which he let handle virtually all of the board negotiations, these people said. Durban used his close ties with Steven Ballmer, the chief executive of Microsoft and to whom he had sold the video chatting service Skype for $8.5 billion, to bring in Microsoft as a partner.
Microsoft was wary of getting involved, fearing fracturing relationships with other partners, according to a person briefed on its deliberations. The software company insisted on providing a loan instead of taking equity in the newly private Dell. Silver Lake also hired four banks to arrange the $15 billion in financing.
By the time word of the deal talks leaked last month, the two sides had the outline of a final proposal. But Dell’s special board committee, led by Alex J. Mandl, battled with the buyers on price until Monday night, pressing for the highest possible bid.
Hamstringing them was a lack of other potential buyers. The committee’s advisers had unsuccessfully approached both KKR and TPG Capital, another big investment firm, hoping to flush out another offer. And despite the talk last month, no strategic buyer emerged as a rival.
Secrecy was important. Dell was known in talks as “Mr Denali” — a nickname he liked so much he referred to himself by it regularly — while the PC maker was “Osprey” and Silver Lake was “Salamander.”