Why going private won't save Dell
Desperate times, they say, call for desperate measures. And a corollary to that rule is that desperate companies are sometimes driven to make desperate moves. That seems to be the case with Dell this week, as reports emerge that the company is considering a leveraged buyout on a large scale rare in the tech industry. Such a move may end up swapping one set of complications for another, while doing little to solve the deeper problems facing the company.
A Bloomberg report that Dell was talking with two private-equity firms about a buyout caused the company's stock to surge 13 percent Monday. The shares rose another 7 percent today after Reuters said that talks were advancing with several banks lining up the necessary financing. While the impressive two-day rally lifted the stock up to $13.17, it erased only eight months of declines. Dell is still trading below its 200-day moving average – a reminder of how far Dell has fallen in the past year.
The rally has come despite widespread skepticism that a buyout will happen in a financial market still skittish about big, risky deals. Over at Fortune, Dan Primack gave the deal a one-in-five chance of being brought to completion, making a detailed case for his skepticism. Wall Street analysts are also doubting the likelihood that enough financing can be lined up to pull off what would be the biggest corporate buyout since the Great Recession and one of the largest tech LBO's ever.
Whether it goes private or remains public, Dell still faces the same question: How the hell is it going to turn things around quickly? The transition from public to private will simply offer the company a different set of options, that is, a new set of challenges to overcome to keep investors from losing faith in the company.
Few companies relish the scrutiny that comes with being traded on public markets – the quarterly earnings game, and the beat-downs that can come from investors and short sellers when earnings fail to satisfy expectations. Going private can allow Dell to take bold steps that might not fly with skittish public investors.
But there are downsides. Going private can limit Dell's ability to acquire other companies with equity, an option that it might need to continue its expansion away from low-margin PCs and into higher-margin IT services. In the past year Dell spent $2.5 billion for Quest Software and another $2.4 billion for a series of smaller acquisitions – all in cash. Dell has another $11 billion in cash, although the bulk of it is believed to be held in overseas accounts to avoid paying U.S. Taxes.
Dell will still have to please investors, namely the ones that are brought in to buy equity in the privately held company. And then there are the credit holders. A leveraged buyout would also expand Dell's long-term debt, currently at $5.3 billion. First Data went private in a $25 billion leveraged buyout in 2007, and it's still struggling to pay down $23 billion in debt.
Down the road, this could become a problem for Michael Dell, who founded the company and returned as CEO in 2007, intent on reviving the company into an IT services and consulting giant. Dell still owns 16 percent of the company, but he may find himself at odds with other investors who are simply interested on earning a return on their investment.
The turnaround that Dell has been engineering for several years has been slow going. Dell still has more than half of its revenue from desktops and laptops – a business that is deteriorating at an accelerating rate. A year ago, its PC shipments had been shrinking by about 10 percent a year, but data from Gartner showed that that figure declined by 21 percent in the fourth quarter of 2012. Meanwhile, as PC prices have tumbled, Dell's product gross margins have declined to 18 percent in the past nine months from 21 percent in the same period a year earlier.
If that's not bad enough, the new markets that Dell has been pushing into have been lackluster as well, thanks to a global slowdown in IT spending. According to the company's most recent 10-Q filing, Dell's software revenue in the most recent quarter declined 11 percent on year, while storage revenue fell 16 percent. The lone bright spot in the quarter was server revenue, which rose 11 percent.
So Dell may buy itself some time by going private, but it may not be enough time to allow for a strong turnaround. It will need to generate steady cash flows to pay off loans old and new. It will need to somehow do this while carrying an ailing $20 billion PC business, and compete in a sluggish IT services market. And it will need to appease its new private investors.
If Dell can't do that – and right now it's hard to imagine it will – the company may be split up and sold in pieces. Or it could be merged with another company, say Hewlett-Packard. HP is a lot like Dell – both are having a tough time pushing into software and services, both are insisting that having dying PC business is an asset and not a liability in this strategy.
The big difference between Dell and HP right now is that HP is also hobbled by a bizarre scandal involving its Autonomy acquisition. You have to wonder if that isn't Dell's opening line as it talks to potential lenders and investors: Hey, at least we're not HP! Because, for now, that's about all Dell has going in its favor.
(Image courtesy of eli brown on Flickr)