Dell – As good as it gets

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Icahn’s surrender still leaves an uphill battle.

  • Carl Icahn has given up his fight to take control and turn around Dell leaving the field clear for Michael Dell and Silver Lake.
  • The proposal now stands at $13.88 per share including the $0.13 dividend that was offered to keep Icahn on the back foot.
  • At this price and with Icahn bowing out the deal is almost certain to pass at the shareholders meeting later this week. (Thurs 12th Sept).
  • The question now is: what will Dell and Silver Lake do to turnaround the company.
  • The group has two choices:
    • One. It can reinvest in R&D (margins would fall in the short-term) in order to properly address the changes in the PC market.
    • Form factor, look and feel are important again but without any R&D there is no chance to really emerge ahead of the pack.
    • Most PC makers outsourced R&D to their ODM partners as Intel and Microsoft drained the PC industry of profitability leaving them unable to differentiate in the new environment that Windows 8 brings.
    • Investing in R&D could make Dell products exciting again and stop the inevitable market share loss that I see happening as Asustek and Samsung come to market with innovative and differentiated products.
    • Two. Break the company up, sell off the PC business and focus on software and services.
    • This would restore growth but it would cause the revenues to more than halve before growing again but off a much lower revenue base.
    • Dell has around $10bn in debt which is likely to grow meaningfully to acquire the equity.
    • The PC market is in very poor shape but I suspect that Dell’s PC business is big enough such that it could be patched-up and sold off generating enough proceeds to pay down the debt.
    • This would leave Michael Dell and Silver Lake with the equity of the software and services piece.
    • Get this growing steadily and follow up with an IPO and one has the makings of a very tidy profit.
  • I suspect that Silver Lake and Dell are looking mainly at option 2 as it is the least risky and is a simpler and quicker proposition.
  • That being said the real risk lies in being able to sell the PC business and getting enough money for it to pay down the debt.
  • This in itself is risky enough and could result in disaster if the PC market continues to deteriorate and the new management is unable to do anything about it.
  • Dell and Silver Lake are proposing to pay 14.6x 2013 PER for a business which is in no better shape than HPQ.
  • HPQ is currently trading on 6.3x 2013 PER which makes the offer from Dell and Silver Lake very attractive in my view.
  • This is especially the case as current shareholders will not be risking their shirts in the turnaround and are already benefitting in some upside.
  • Given the share price is very close to the offer price, selling now just in case the vote fails, looks like the safest option.

 

RICHARD WINDSOR

Richard is founder, owner of research company, Radio Free Mobile. He has 16 years of experience working in sell side equity research. During his 11 year tenure at Nomura Securities, he focused on the equity coverage of the Global Technology sector.