If Dell is to take on IBM and Hewlett-Packard in computer services, the PC maker will need acquisitions beyond its $3.9 billion Perot purchase
Dell's $3.9 billion acquisition of Perot Systems vaults the computer maker into the market for technology services, an area it has coveted as the PC market faltered. But Dell (DELL) will need to make additional deals if it hopes to mount a credible threat to IBM (IBM) and Hewlett-Packard (HPQ) in services, analysts and bankers say.
As it moves to bulk up in services, Dell will also need to expand beyond Perot's core strengths in health care and government and redouble efforts to bring in business from outside the U.S.
Dell snared Perot Systems (PER) after two years of on-and-off negotiations, announcing the acquisition on Sept. 21. CEO Michael Dell said in a conference call that he began talking to Perot Chairman Ross Perot Jr. about a deal in 2007 and that the conversations heated up this summer. Dell has long known Perot Systems founder and former Presidential candidate Ross Perot and his son.
Buying Perot Systems furnishes Dell with a technology outsourcing and services provider that will help the computer maker diversify beyond its slumping core business. Perot is strong in the health-care and government markets, areas that stand to benefit from increased spending by the Obama Administration. "There are going to be some large contracts out there," says Jarrad Zalkin, vice-president at investment bank TM Capital. "If you have staying power on the services side, you'll be in a preferred position."
Computers, Microsoft Software, and Services
Dell could augment its services business by buying smaller companies that complement Perot's business and help automate delivery of technology services, says Jayson Noland, a senior analyst at Robert W. Baird, who has a "neutral" rating on Dell shares. But integrating Perot, which has 23,000 employees, won't be easy for Dell, and Noland says he doesn't expect to see Dell make "another headcount-heavy deal in services." In a research note to clients issued on Sept. 21, Noland said he expects Dell to remain acquisitive, perhaps acquiring data backup software company CommVault Systems (CVLT).
Another advantage Dell holds in technology services is a close relationship with Microsoft (MSFT), whose software is often sold alongside Dell PCs, servers, and storage systems. Consulting companies that can stitch together Dell hardware and Microsoft software for customers would also be likely targets for Dell, says TM Capital's Zalkin. Among the companies that fit the bill are Perficient (PRFT) and privately held Tectura. Another company that specializes in so-called systems integration, Ciber (CBR), has expertise selling to the federal government. On Jan. 9, Dell said it paid $12 million for units of consulting company Allin that specialize in Microsoft technologies. "The missing piece of the puzzle [for Dell] is systems integration," says Zalkin.
Yet Dell will face some tough challenges as it folds Perot Systems' $2.8 billion business into its own. Perot has struggled for years with slow sales growth, tight profit margins, and powerful competitors. It has imposed layoffs and handed out small salary increases for several years, says a former Perot Systems executive, speaking on condition that he not be identified. "They've been cutting like crazy trying to keep their margins up," this person says. "They've been looking for the right kind of deal for a while."
Dell offered $30 a share in cash for Perot, a 68% premium over the company's closing stock price on Sept. 18—a figure many analysts said was too rich. Shares of Perot Systems soared 65% on Sept. 21, closing up 11.65 at 29.56. Dell shares lost 68¢, or 4%, closing at 16.01. The Perot acquisition is scheduled to close in Dell's fiscal fourth quarter, which ends in January, and Dell said the deal would add to earnings in its fiscal year that ends in January 2012.
Eye on Western Europe, China, India
IBM and HP have built big leads in the businesses of managing computers and software for companies and government agencies and of building customized computer systems for them. IBM reported $9.1 billion in services revenue in the second quarter, or 39% of total sales. HP in May 2008 bought Electronic Data Systems, which Perot also founded, for $13.9 billion. In its second quarter, which ended on July 31, Dell's services revenue was $1.2 billion, about 10% of sales. HP declined to comment on Dell's purchase.
Since Perot Systems derives about 27% of revenue from the federal government and 48% from health-care IT services to hospitals, Dell said it will continue to look for further acquisitions beyond those areas. Dell will also look to expand sales of outsourcing and software development services beyond the U.S., the source of about 88% of Perot's revenue, says Dell Chief Financial Officer Brian Gladden. More dealmaking could help. "The biggest opportunity for us is geographic expansion" in Western Europe, China, and India, Gladden says. "We have an $8 billion services business now," Gladden says of the companies' combined annual sales of specialized computer services. "We'd like to make it bigger, and we'll make investments to do that," he says.
The Perot Systems acquisition is the latest in a surge of tech-industry dealmaking in the past week. On Sept. 14, software company Intuit (INTU) bought startup Mint.com for $170 million. The next day, Adobe Systems (ADBE) spent $1.8 billion to buy software company Omniture. Google (GOOG) bought a small technology company called ReCaptcha on Sept. 16.
As stock prices have rebounded and companies sense that the worst of the economic crisis has passed, they are becoming more comfortable taking risks to build out portfolios of products and services. Tech companies "are willing to thin out their balance sheets a little to do some deals," says Zalkin. A weak dollar has also supplied tech companies with cash they can use to buy growth because takeover targets remain reasonably priced. "Global tech companies are using this as an opportunity to use some of that excess cash to do M&A," says Bruce Chizen, former CEO of Adobe and a venture partner at Voyager Capital.
Perot CEO Altabef Will Lead Dell Unit
Since returning as CEO in 2007, Michael Dell has tried to diversify beyond PCs. Dell's profits fell 23% and sales declined 22% in the second quarter as sales of desktop PCs and laptops fell 33% and 21%, respectively. Dell had been asking both senior and junior Perots for years whether the companies should merge, according to Gladden. Talks accelerated in the past two months.
But Perot Sr. had long been waiting for a deal that would not only value the company at about $30 a share, but also give his executive team a large measure of control, according to the former Perot Systems executive. Perot Systems CEO Peter Altabef will lead the new Dell services unit from Plano, Tex., about a 25-minute flight from Dell's headquarters in Round Rock, Tex. Dell has also retained other senior Perot Systems managers. And company Chairman Perot Jr. will likely take a seat on Dell's board, Gladden says.
Dell hasn't been known on Wall Street as a company with M&A chops, but it's taking steps to change that perception. It hired a mergers-and-acquisitions executive from IBM in June who has mainly worked on strategy because of an ongoing legal dispute between the companies. Since the spring, Dell has signaled an increased willingness to make acquisitions. "That's one of the concerns our investor base has—a lack of experience doing large transactions," Gladden said in a July interview. "I wouldn't say it's a core competency of the company."
A successful annexation of Perot Systems would go far to persuade investors that Dell has the wherewithal to grow through further dealmaking.