As I’m not a journalist, I don’t have a need to leap in and make commentary when big announcements/acquisitions are made. Instead I’ve taken the time to look at all of the comments already out there and formulate a more considered opinion. I doubt the acquisition of Dell by EMC has escaped most people’s attention – it was even reported earlier this week on the BBC. News about Dell gets more widespread media coverage because the company is a leader in consumer products, however this acquisition is all about cementing the company’s hold of the enterprise market place, which offers higher margins than the PC business.
Facts & Figures
What do we know so far? Dell Inc (or rather the private holding company) has put forward an offer to EMC share holders worth the equivalent of $33.15 a share. I say “equivalent” because this value is comprised of two components; there’s $24.05 for each EMC share held and a second “tracker” stock in VMware of one share for every nine EMC shares held (or approximately 0.111). The tracker component adds another $9.10 to the valuation. Issuing the tracker stock allegedly reduces Dell’s holding in VMware from just over 80% to 40%, although Dell will hold all the voting rights. Note also that tracker stocks typically don’t receive dividends and I think that’s the case in this instance. Since the announcement was made at the beginning of the week, VMware shares have dropped by 16.5% ($81.78 to $68.29 at time of writing). EMC shares have also fallen, but have since recovered a little. However it is far from clear which entity will issue the tracking stock (see the link to the FT article later), so Dell may continue to own 80% of VMware shares after all.
In total, Dell will borrow money to complete the deal, resulting in a total debt of around $50 billion. HP’s CEO Meg Whitman highlights that servicing this debt will remove around $2.5 billion from the business that could have otherwise been invested in R&D. However she fails to mention that EMC is sitting on around $15 billion in cash and investments, recently purchased back $2 billion of shares and issued a dividend of $255 million, all of which in the future will be directed towards reducing the debt. It’s also likely that the combined Dell/EMC will sell off some non-core assets (like Pivotal) which will go some way to tackling the debt mountain. Note that Dell has indicated that the first 18-24 months will see efforts to reduce the debt, meaning “restructuring” – sell-offs and layoffs.
So why didn’t Dell just put forward an offer for the full share price, instead of using the VMware tracker device? It’s probably because raising the full amount of cash would have created too high a debt that would have needed servicing while VMware shares were sold off. Those VMware shares would have been sold at a depressed price and not been as valuable as the tracker. As mentioned, VMware shared have dropped 16.5% already, but this doesn’t affect the current “offer” to EMC shareholders, which was based on the price at the time of the announcement. If you want to read a lot more in-depth discussion on the financials of the deal, check this link to the FT out, which even includes suggestion that Dell might re-float the company in some format.
So, now we know the numbers, but why would this deal make sense to do in the first place? Looking first from the perspective of Dell, their business at the time of privatisation was made up of around 33% from large enterprise solutions. The remainder comes from consumer (19%), SMB (24%) and Public (24%). Gross margin is around 22%. In contrast, EMC’s EMC-II division (the part that sells storage) sees gross margins of 55% and VMware sees 88%. There’s significant benefit to Dell’s bottom line by merging in the EMC business. PCs and laptops aren’t high margin businesses (unless you are Apple) and we’ve seen HP go through the process of splitting the PC and enterprise parts into two (completing next month). There was also a rumour that Silver Lake Partners tried to find a buyer for Dell’s PC business ahead of Monday’s announcement.
However from an EMC perspective, the benefit of this deal is less clear, and to my mind represents a degree of capitulation from Joe Tucci and the rest of the EMC board. Selling the company is an implicit acceptance that EMC didn’t have the inertia or ability to transform into a full solutions business. Traditional storage sales are declining consistently quarter on quarter, as reported in this article on The Register. EMC has had some success in replacing existing hardware solutions with others (like XtremIO), but hasn’t seen the expected increase in revenue from software products like ScaleIO or other parts of the federation like Pivotal. About 18 months ago, I commented that EMC should have acquired IBM’s server business and sold their own solutions (that opinion was derided at the time). Instead the company continued with VCE and effectively “outsourced” hyper-converged solutions to partners with EVO:RAIL and VSPEX Blue. All done to keep the concept of the “federation” in place (more of that in another post). Outsourcing the delivery of hyper-converged solutions may have seemed like a clever idea (EMC simply take a cut of the profits) but it only works if you actually sell some of them.
So the long-term future for a standalone EMC looked bleak. Remember there were rumours of an acquisition by HP earlier this year, which fell through, apparently because EMC were asking too much money for the company. More importantly, Joe Tucci probably didn’t want a breakup of the company (as being pushed for by Elliot Management, an activist investor) but wanted to retain the federation to justify his personal strategy. Selling to Dell perhaps seemed like a better solution, because both the Federation remains intact (for now) and Elliot can’t cause trouble for a private firm.
So, overall, Dell comes out with a bigger and stronger company (in the short term). EMC gets an exit strategy for Joe Tucci. At this stage, the deal looks to be a good one for both sides. Now I say “at this stage” for a good reason – what’s good today might not be the best strategy tomorrow.
In future posts, I’ll look at portfolio rationalisation, benefits/disadvantages for customers, the federation and where we see things going long-term.
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