Until recently, Dell was banking on M&A to fix its ailing business as PC sales eroded along with its share price. In June 2009 Michael Dell spirited away M&A guru David Johnson from IBM Corp., touching off a legal firestorm with IBM alleging Johnson had breached his contract. When all was said and done, Dell had snagged a great new M&A weapon. Previously, the company had done a smattering of some 10 acquisitions between 2002 and 2009, a fraction of what rivals Hewlett-Packard Co. and IBM were churning out.
Now Johnson has left for Blackstone Group LP and Dell is reportedly in talks with a group led by Silver Lake to nail down $15 billion in financing for an LBO. Michael Dell would probably like nothing better than to go private and thumb his nose at pesky shareholders who refuse to cut him slack as he toils to turn Dell around.
Last year, Dell bought eight midsized companies worth $3.5 billion, according to Dealogic. While most investors like what Dell has been buying -- deals aimed at weaning the company off its PC dependency and toward new products and services in a mobile world -- shareholder returns have been dismal. Dell's total return to shareholders has underperformed the S&P 500 technology index by 77% over a five-year period, according to S&P Capital IQ. HP has done even worse, underperforming by 88%. On this basis, both are among the worst performers of the 70 stocks in this broader tech index.
Some critics nick Dell for sticking to smaller deals because of the extra time necessary to ramp up market share in fast-moving new businesses. Smaller deals also take longer to make a big difference on the revenue line.
Conversely, others worry Dell will be tempted to splash out on an overpriced megadeal to speed things along.
It's easy to understand why Michael Dell is tempted by the siren call of the LBO, and it's equally easy to imagine HP would be too, though HP is probably too far gone to pull it off. In a recent analyst note, Barclays plc said if anything, the Dell LBO speculation may spark talk of an HP breakup.
In any event, HP would be hard-pressed to buy its way out of its current problems, given it now has a monster debt load of $28 billion, more than double its $11.7 billion in cash. Dell, in contrast, has $11.4 billion against $9 billion in debt, according to S&P Capital IQ -- not great, but at least not a negative balance. When it comes to debt, though, both have fallen incredibly far from five years ago. Today, HP's total debt to total equity is 127%, compared to just 21% five years ago. Dell, which has a ratio of 89% today, had a mere 9.4% five years ago. Once both were cash kings. Now, debt ratios and poor shareholder returns speak to the high cost and risk of using M&A as a growth tool in an industry growing with ruthless speed.
No wonder Dell is looking for a break. But the question remains, can it accomplish in private what it has yet to achieve in public using M&A?
Roger Kay, a technology analyst and founder of Endpoint Technologies Associates Inc., believes Dell will need roughly another five years to turn itself around. He's a fan of the LBO option because, he says, it will shield the company from more bad press as it goes through necessary changes.
"If you imagine them stepping away from the old and at a certain point downsizing the [PC] business, let's say they serve fewer customers. They want more of the revenue to proportionately come from the newer businesses, that is the enterprise solutions side of the house. The problem with that is the transition is ugly, you may have a precipitous revenue decline at first," Kay said.
Another question is whether Dell would continue to do acquisitions as a private company, given all the additional debt that will be weighing on its balance sheet, and if so what kind of deals it would do if it could afford to buy anything. Some have been feeling more optimistic about Dell's prospects in making an LBO succeed with the latest rumors that Microsoft Corp. is apparently willing to throw in as much as $3 billion as an investment in the deal. At the very least, it's a sign that Microsoft wants to see its hardware partner survive and thrive.
"Microsoft has always seen it as good business to throw lifelines to its downstream partners," Kay said. Conversely, what happens if Dell doesn't do the LBO and stays where it is?
It will most likely be forced to keep buying other companies -- and it may be forced to buy a big one. Barclays analysts said in a January research note that "the large-cap tech universe requires constant M&A to refresh intellectual property (Oracle Corp., IBM and Cisco Systems Inc. all follow this model)." And if it does manage to go private, Barclays said, "the LBO 'math' works only if the company can access or cheaply borrow against a large portion of its cash holdings." In other words, it will still need to buy other companies.
How well that process goes will be determined by the latest generation of dealmakers at Dell -- Chris Kleiman, who will be in charge of corporate development, and Prakash Jothee, who will run the corporate strategy team. Both have replaced Johnson, who is credited with leaving behind a top-notch M&A infrastructure he built over the past three years. Everyone will be watching to see how masterfully they leverage it. The question is, who will be judging? A new team of private equity executives that presumably will have some extra patience, or a restless crowd of shareholders?
Steven C. Todrys joined Evercore's investment banking business as a senior adviser, focusing on transactional tax and structuring solutions. For other updates launch today's Movers & shakers slideshow.
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