Dell – As good as it gets

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 12^th 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.