Dell management must be suffering from whiplash.Once one of the “four horsemen of tech”, the computer company rose to prominence by selling standardized boxes to enterprise customers. The model was operational discipline and minimal R&D.
In the 80s and 90s it worked like a charm. And then the 00s came, and the world was turned on its end.
Now, with a $24.4 billion buyout offer on the table, led by CEO and founder Michael Dell in partnership with Silver Lake and Microsoft, this one-time stock market darling is slinking out of view of the public markets, in the hopes of making the changes that have eluded the company to date.
The nexus of innovation shifted from the enterprise to consumers, and the dominant computing platforms shifted from the desktop to smartphones and tablets. A proliferation of cloud-based offerings have reduced the amount of hardware most companies require, as enterprise customers began to grasp that they wanted computing power and storage, not servers, and if they could buy the former without buying the latter, they would do so.
In short, Dell is a casualty of the changes wrought by the successes of Apple (AAPL, $475) and Amazon (AMZN, $262) and the failures of Microsoft (MSFT, $28). The one thing Dell has to be thankful for is that with its coherent story and more manageable size, it has a wider range of options to deliver shareholder value than does struggling tech giant Hewlett-Packard (HPQ, $17).
- Apple: having taken over as the engine of innovation from the Wintel duopoly, Apple has also appropriated the majority of the profits from IT sales, securing premium pricing for its products. The company that lived and died by innovation is now dominating the market through both innovation and the network effects of a large and growing entrenched user base. Dell has no such advantages.
- Amazon: Through its Amazon Web Services, Amazon has brought robust, enterprise-level computing and storage capability to its customers without the hassle of buying and maintaining the hardware. In the 90s one of the first items a startup spent money on was hardware, but Amazon has eliminated that need, while also offering larger enterprises the tantalising possibility of substantially reducing IT spending without sacrificing organizational capability.
- Microsoft: For years Dell and Microsoft were strong partners, with Dell providing the boxes that ran Microsoft software and Microsoft taking on the burden of R&D. As Apple products, in particular the iPad tablets, gain traction, that approach has broken down. Concerned with the lack of progress from its hardware partners, Microsoft has embarked on its own tablet, the Surface.
Dell was always somewhat miscast as a tech darling. An operationally focused company generally does not garner the type of hype that Dell once enjoyed, but the explosive growth of PC sales demanded shareholder attention. That growth obscured the fact that Dell was and remains a fast follower, perhaps with more of an emphasis on the “follower” than the “fast”.
When asked in 1997 what he would do if he were in charge of a then faltering Apple, Michael Dell said: “What would I do? I’d shut it down and give the money back to the shareholders”.
I bring up this quote (which has been cited a great deal lately), only to illustrate the dramatic change in the tech world since those comments in 1997.
- In 1997, the deepest pool of profit for computer companies was in selling to enterprise customers, and enterprise customers wanted standardization and volume. Consumer products are now clearly the drivers of innovation. Corporate CIOs are increasingly supporting whatever tablets and smartphones employees prefer, killing the value proposition of standardization and volume that Dell relied on.
- Consumer products are now clearly the drivers of innovation. Corporate CIOs are increasingly supporting whatever tablets and smartphones employees prefer, killing the value proposition of standardization and volume that Dell relied on.
- The “Wintel” (Microsoft Windows and Intelchips) duopoly created a virtuous upgrade cycle in which faster chips permitted larger software packages which demanded faster chips and so on. Windows 8 has been a disappointment, and enterprise customers have become increasingly frustrated with software upgrades that add little value but entail considerable costs. Additionally, the growing use of tablets has thrust Dell into competition with onetime partner Microsoft (via that company’s Surface tablets). The virtuous upgrade cycle has ground to a halt.
- Windows 8 has been a disappointment, and enterprise customers have become increasingly frustrated with software upgrades that add little value but entail considerable costs. Additionally, the growing use of tablets has thrust Dell into competition with onetime partner Microsoft (via that company’s Surface tablets). The virtuous upgrade cycle has ground to a halt.
Need for a Change
- Valuation: If you believe a turnaround is feasible, Dell shareholders have been had. The $24.4 billion offer currently on the table implies a paltry EBITDA multiple of 5.5x. Given the tax advantages of a more leveraged structure, as well as the strong background of investor Silver Lake in the nascent field of technology company turnarounds, the buyers have positioned themselves for windfall gains if they are successful. Granted, this is somewhat better than prior to rumours of a buyout, but it is hardly a robust valuation.
- Performance: Revenue (ttm) of $58.7 billion is under pressure, with quarterly revenue growth at -10.7%. Profitability is minuscule, with an operating margin of 5.74%, though operating cash flow is strong at $3.7 billion and total cash is robust at $11.3 billion.
Shareholders of Dell are in many ways suffering from the fact that their company was just small enough for a buyout to be feasible, and had struggled long enough for a bargain basement price to still represent a premium to the share price prior to the announcement. But the success of this investment is not assured. Dell’s profitability is weak and its revenue growth is negative, though the company does continue to generate strong cash flow and maintains a sizeable cash balance.
Turnarounds are messy, and tech turnarounds doubly so. Dell is a company that needs to make considerable changes in its structure in order to return to an acceptable level of profitability. The type of wholesale restructuring that is needed is best done out of the glare of the public markets. The hope for this company is that the buyout will permit Dell to execute a comprehensive restructuring out of the glare of the public markets
About the Author
David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. He can be reached at 312-505-7238 or at [email protected].
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