To perform painful surgery on its business model, Dell needs to take the company private. Seeing challenges in raising the needed $22B, Microsoft “generously” proposes to contribute a few billions. Is this helping or killing the deal?
The news broke two weeks ago: Dell wants to go private. The company would like to buy back all of its publicly traded shares.
The Apple forums are abuzz with memories of Michael Dell’s dismissal of Steve Jobs’ efforts to breathe new life into Apple in 1997:
What would I do? I’d shut it down and give the money back to the shareholders.
Is it now Michael’s turn to offer a refund?
Now we hear that Microsoft wants to lend a hand, as in “several billion dollars”. The forums buzz again: It’s just like when Bill Gates came to Jobs’ rescue and invested $150M in the Cupertino company, thus avoiding a liquidity crisis.
The analogy is amusing but facile. Dell 2013 isn’t Apple 1997. A look at Dell’s latest financials shows that the company still enjoys a solid cash position ($14B) and a profitable business (3.5% net profit margin). It’s profits may not be growing (-11% year to year), but the company is cash-flow positive nonetheless ($1.3B from the latest quarter). There’s no reason to fold up the tents.
As for Microsoft’s involvement: The Redmond company’s “investment” in Apple was part of a settlement of an on-going IP dispute. Microsoft avoided accusations of monopoly by keeping alive a highly visible but not overly dangerous adversary.
So what is Dell trying to accomplish by going private? To answer the question, let’s step back a bit and explore the whys and hows of such a move.
First, we have the Management Buyout. Frustrated with Wall Street’s low valuation, executives buy back their company “on the cheap” and run it in private for their own benefit. This rarely ends well. Second-guessing the market is never a good idea, and the enormous amount of money that’s needed to pay off shareholders puts the execs at the mercy of bigger, smarter predators who turn out to be the ones who end up running the company for their benefit.
A good reason for going private is to allow a company to shift to a radically different business model without being distracted by Wall Street’s annoying glare and hysterics. This is what Dell is trying to do. They’re not shutting down shop, they’re merely closing the curtain.
Is it necessary to privatize for such a move? For an example that never came to pass, recall Bill Gates’ suggestion, in 1985, that Apple should get out of the hardware business and, instead, license the Mac operating system. At the time, the average revenue per Mac exceeded $2,500; a putative Mac OS license would have sold for $100. The theory was that Apple would eventually sell many, many more OS licenses than it did Macs.
The pundits agreed: “Just look at Microsoft!”. Apple would jump from one slowly ascending earnings curve to a much steeper one.
Now picture yourself as John Sculley, Apple CEO, going to Wall Street with the following message: “We heard you, we’ve seen the light. Today, we’re announcing a new era for our company, we’ll be licensing Mac OS licenses to all comers for $100 apiece. Of course, there’ll be a trough; licensing revenue won’t immediately compensate the loss of Mac hardware sales. We need am ‘earnings holiday’ of about 36 months before the huge software profits flow in.”
You just became the ex-CEO. Wall Street dumps your shares, effectively telling you to take them back and only return after your “holiday” is over.
As another example that didn’t happen but probably should have, imagine if Nokia CEO Stephen Elop had taken his company private in 2011. Instead of osborning its Symbian business, Nokia would have had the latitude to perform the OS gender change behind closed doors and reemerge with a shiny new range of Microsoft-powered smartphones.
I’ll hasten to add that these made-up examples are somewhat unrealistic: To engineer a buyout, one must raise amounts of money commensurate with the company’s current valuation. Around 1987, Apple was worth about $2B, a great deal of money a quarter of century ago. In early 2011, Nokia’s market capitalization was about $40B, an impossibly large sum.
Still, thanks to these buyout fantasies, we get the two key ideas: First, Dell wants to go private because it plans to alter its business model in ways that would scare nervous, short-term Wall Street shareholders; second, the required amount of money (Dell’s market cap is about $22B) is a potential deal-killer.
We don’t have to look very far for the changes Dell wants to make. Dell no longer likes its legacy PC business and has made efforts to reposition itself as an enterprise player (expensive iron, software and services). Going private will allow it to perform the needed surgery, stanch the bleeding, and reemerge with a much stronger income statement, rid of low-margin commodity PCs.
When we look at the money that needs to be raised, things become really interesting. Michael Dell’s 15.7% ownership of the company undoubtedly helps, but the $22B market cap is still a big hill to climb. Several buyout firms and banks got involved in preliminary discussions; one group, TPG Capital, dropped out, but another, Silver Lake, has persisted in its attempt to round up big banks and other investors with enough funds to vacuum up Dell’s publicly traded shares.
That’s when Microsoft walks in on the discussions and offers to save Private Dell.
Clearly, Microsoft’s money will help in the buyout…but will its involvement torpedo Dell’s intentions? The NY Times DealBook article makes the case for Microsoft propping up the leading PC maker:
A vibrant Dell is an important part of Microsoft’s plans to make Windows more relevant for the tablet era, when more and more devices come with touch screens.
This would give Microsoft some amount of control over the restructured Dell, a seat on the Board of Directors, perhaps, with ways to better align the PC maker’s hardware with Redmond’s software. Microsoft wants Dell’s reinvigorated participation in the “Windows Reimagined” business.
But note the phrasing above: “Dell is an important part of Microsoft’s plans…” Better vertical integration without having to pay the full price for ownership, the putative “several billion dollars” would give Microsoft a significant ownership, 10% or 15%. This is completely at odds with the buyout’s supposed intent: Getting out of the PC clone race to the bottom.
Or maybe there’s another story behind Microsoft’s beneficence: The investor syndicate struggles and can’t quite reach the $22B finish line. Microsoft generously — and very publicly — offers to contribute the few missing billions. Investors see Microsoft trying to reattach the PC millstone to their necks — and run away.
Hats off to Steve Ballmer: Microsoft looks generous – without having to spend a dime – and forces Dell keep making PCs.
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24 Comments
Microsoft’s involvement in this deal made so little sense to me that I even question your “conspiracy theory” of paying a couple of billion to chain Dell more tightly to high-volume Windows license sales.
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First, the sort of restructuring you describe might need a lot of cash. Absent publicly traded shares to swap, the LBO partners will have to cough up their own money. That of course is almost the exact opposite of most LBOs, where the partners line up debt financing, spin out dog divisions and then pay themselves an exceptional dividend before re-floating the debt-encumbered company. The huge majority of those deals, of course, don’t actually end well; without good growth, it sinks pretty quickly.
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Second, it should be noted that Microsoft’s largesse won’t end up on the balance sheet of the new Dell; it’d be paid out to the soon-to-be ex-shareholders. It might allow the company to keep some more cash but again, the pattern is NOT to carry cash so much as to load up on debt. So Microsoft isn’t so much supplying breathing room as it would be taking control of a company that’s headed for the long, slow decline that it will face unless it finds a new, non-desktop-PC future.
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Dell ALREADY gets a fair share of its revenues from consulting; it’s not like they need to take a shot at an Autonomy. Perhaps the best reason to avoid the glare of the public light is to avoid the bad press that HP has primed bloggers and journos to write. But personally, I’d think the pressure from Wall Street is about one-third what they’d face from a board run by private equity types; if that Board includes any involvement from Microsoft, there could be some real mismatches of objectives.
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So: still not seeing how it makes sense. I guess Microsoft is open to all sorts of new ways of re-organizing their business to reinvigorate the desktop, but this move seems pretty superficial compared to what such reinvigoration would really require.
What’s not to like for Microsoft? Throw a few billion at Dell (like they did with Nokia) and from then on exert their new found power by killing Dell’s substantial Linux business (like MSFT killed Nokia’s Linux projects). The only problem with that is that, due to the pretty generic nature of servers, Dell’s customer can fairly easy switch to HP, IBM, Lenovo, Fujitsu or any other server vendor. What will be left of Dell is a smoking pile of nothing. Instead perhaps Dell should put their Microsoft business on the backburner (which organization would buy W8 anyway?) and bet the farm on Linux based solutions. After all, the rest of the planet already did. Maybe it’s time Dell did too.
Dude that makes a ll kinds of sense.
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Microsoft was successful making Apple II clones, then Mac clones, and now wants to make iPad clones. But nobody seems to be biting this century. Their iPhone and iPod clones also got no traction.
Dell may be profitable, but they are less profitable than many guaranteed investments.
There was a point in about 2006 that longtime PC pundit John C. Dvorak said that everybody in the PC industry should admit Apple won and beg for Mac OS X licenses. Of course, Apple went on to provide those licenses built into a range of touchscreen iPods, no Intel PC required. Amazing to see true believers still fighting for the nostalgic Microsoft PC to be made by HP and Dell, all these years later.
Couldn’t the Management Buyout alternative be just a disguised way for Michael Dell himself get out of his business? Maybe for him it would not be an issue to be eaten by “smarter predators”, as long as they buy *him* out along the way.
He gets a deal for his shareholders *and himself* above market price, PE funds take over management and perform the traditional layoff/spinoff surgery, Dell as it is ceases to exist and Michael Dell will have lived to his “I’d shut it down” words.
Re: “Microsoft generously — and very publicly — offers to contribute the few missing billions.”
And it wouldn’t be the first time that Microsoft has generously and very publicly contributed billions. It’s as though Microsoft were planning alternate sources of income as their Windows + Office empire begins to crumble.
E.g. $1 billion stake in Comcast. $2.3 billion stake in TeleWest. $5 billion stake in AT&T. And that’s only the stakes equal to or greater than $1 billion.
But does it make sense for Microsoft to buy a piece of Dell? And why wouldn’t Lenovo want to buy all of Dell?
Smells like flop sweat.
“As another example that didn’t happen but probably should have, imagine if Nokia CEO Stephen Elop had taken his company private in 2011. [...] reemerge with a shiny new range of Microsoft-powered smartphones.”
OK, I’ll bite, what if Nokia was private? I don’t really see life being simpler for a private Nokia, so I’d appreciate some insight how things would progress differently. In my mind, as long as Elop signs the same exclusivity agreement with MS, it has to discontinue its own mobile OS products soon afterwards. Top Nokia management can either announce this transition publicly or let it leak from disgruntled employees in drip drip of bad news. Hence, the quandary is no different whether Nokia is public or private. If Elop makes the same announcement about immediate discontinuation of Symbian and all other in-house mobile OS development, how would Nokia’s finances or sales be any different? Would Nokia’s ownership structure matter for the carriers buying Nokia phones? For retail shoppers? Developers? Wouldn’t MS still want to announce to developers that Nokia with all its might is changing sides to get more of them make apps for WP phones?
The world may not have known exactly how much money Nokia was losing each quarter or exactly how many (or few) Symbian phones it was selling, but many public companies hide much of these details and market research companies are still able to make rough estimates. Bad press about Symbian sales falling off a cliff would not disappear completely and it may have become even worse, with many rumor mongers filling in the news vacuum by publishing their pessimistic estimates, unconstrained by periodic audited results.
Do we have any idea how much it costs to make a Surface RT? The pricing of Surface Pro suggests that making IT costs a fortune. Meanwhile MS is barely in the black after a decade of XBox sales.
All these suggest that
(a) MS understands that TIGHT integration between SW and HW is part of what it takes to make delightful products. (Apple is obviously the model here.) BUT
(b) MS doesn’t actually know how to make the HW it wants available to see at prices low enough to be competitive.
The solution is to acquire some degree of control over a company that does understand manufacturing and which can, one way or another, be “incentivized” into making HW that matches MS’ targets, and matches those targets well, not grudgingly and with as much cheating as possible (cf the demise of the UltraBook, with constant gaming of Intel’s specs).
MS has managed to achieve this, to some extent, with Nokia, but Nokia only covers phones. If they can pull Dell in, they can extend this to PCs and tablets.
And they can actually do this in a way that meets both their goals.
Such a scheme will (at some point) allow MS to exit the Surface business, declaring victory by saying that they have proved their point of what a Windows tablet should be, and no longer need to provide “guidance” to manufacturers.
It would also allow Dell to, mostly, exit the consumer PC business. Dell, at least the consumer-facing part, could become like Apple — a manufacturer of only a few high-end HW platforms, but those platforms are all tailored to exactly what MS requires for optimal performance of its SW. Buying a Dell could be, like buying a Nexus, something of a guarantee that you are getting the experience the SW vendor had in mind, untainted by whatever nonsense a HW vendor added to the system or removed (in the form of lousy HW).
Isn’t there a third option where MS gains a safety net opportunity to conveniently take over the PC portion of Dell’s business at some point in the future, if Ballmer decides he needs to? Doing it this way allows them to keep the window open longer and also gives them the opportunity to learn more about the business in the meantime.
@ Walt French: You’re right, it’s not clear how this makes sense.
Regarding MS cash going to current sharelholders, it’s lile any other money put into the deal. This isn’t a situation where Dell _needs_ more cash to survice, it’s got about $14B currently. But $3B from MS would get it about 15% of the private Dell, thus giving Redmond a say in Dell’s affairs — something Silver Lake might not like at all as they want Dell out of the PC biz.
You’re right again when you think of Dell as a potential manufacturer for MS-designed Surface hw. Not sure how this would help the HP relationship… Ooops, we just hear HP will announce a Google Chromebook. Isn’t this fun?
@ Tatil: You’re right to question my Nokia “thought experiment”, I’m not too sure about it either. That said, life is a lot easier for a CEO when you don’t have to tell Wall Street what you’ll be doing, what it’ll cost shareholders, when exactly it’ll get done and so on. Sure, info always leaks, but when you’re private, that’s all it is, a leak, without impact on the price of shares, without irate shareholders…
@ Maynard Handley: Yes, MS could want a captive hw maker for its Surface tablets. But, as discussed in another comment, try tell this to Silver Lake or any other LBO fund. They don’t want MS to effectively control Dell while only putting a couple of billions (I know, in the real world that’s still a lot of money). They, Silver Lake, are the ones who want control.
Looks like Microsoft just made Dell a piece in its Game of Thrones.
@JLG. “Fun” doesn’t begin to describe it!
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I’d be interested in your thoughts about how this fits into broader trends. Seems that “services” has been the refuge for failed computer manufacturers at least ever since Cray’s CDC morphed into Ceridian (which has been doing OK, it seems, for a couple of decades in its new role). I don’t see that Dell has actually torn the cover off the ball with its 2009 acquisition of EDS, but it must pay the rent. Now that Gerstner’s perfectly-timed move out of PCs has become the playbook for everybody else, how many more Lenovos are there to snap up these PC Businesses In Name Only?
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The other important trend, of course, is that Windows is slipping from absolute hegemony over personal computing, to essentially #3 behind Google and Apple. Chromebooks (as you say) and Android will dictate the non-Apple technology decisions, even if only because they will do so at the margin. If I understand Clay Christensen’s model, the pressure is towards interchangeable parts tailored towards the dominant OSs; that makes a Dell (even, partial) acquisition a huge distraction for the missing 10-year Microsoft strategy.
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I have some not-quite-articulatable belief that our last-decade OS wars will soon settle down into minor differences in languages (rather as Europe has changed since the twelve centuries of Armies On The Wrong Side of the Rhine ended). In this world, competition will shift towards being the best at matching specific customers’ needs, rather than exploiting hegemony over a proliferation of devices. For the life of me, Dell seems the LAST organization that could help Microsoft in this effort, just as it’d be well down the list of firms that I’d pick to spearhead the derrière garde effort of keeping cash flow coming from Windows as long as possible.
JLG – a discussion on a possiblity of Apple going private would be interesting. With $130B in cash maybe the idea is not too far fetched as its very clear that Wall St just doesn’t understand Apple.
@karthik re: private Apple.
At not much more than 3x cash now no doubt the topic has been raised internally. But It would take at least $600B and more likely $700B to take Apple private. That’s a lot of money to raise, and probably can’t be done without simply becoming beholden to a different set of stakeholders. (Though Tim Cook & Co could probably put a billion or two in their pockets along the way.) I don’t think it would be good for Apple though.
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