Dell’s Drop Mirrors Descent of PC Industry in Mobile World: Tech

Feb. 5 (Bloomberg) -- Dell is going private in a deal valued at $24.4 billion, undertaking the biggest leveraged buyout since the financial crisis. Cristina Alesci reports on Bloomberg Television's "Street Smart." (Source: Bloomberg)

Dell Inc. (DELL)’s path from personal- computer leader to buyout candidate mirrors the descent of an industry left behind by a raft of upstarts better equipped to capitalize on shifting consumer and business technology demands.

In a deal valued at $24.4 billion, the PC maker is going private in a leveraged buyout by Silver Lake Management LLC and Chief Executive Officer Michael Dell, who regains majority control of the company he founded in 1984.

Dell pioneered low-cost manufacturing and direct-to-buyer shipping, helping transform computers from bulky office machines costing thousands of dollars apiece to devices that every household could afford. It rode that focus on expense reduction to the top of the PC industry. Yet the company, along with many of its peers, failed to adapt as customers lost their appetite for desktops and even slimmed-down laptops, opting for a new class of mobile machines -- smartphones and tablets.

“Everything in our high-tech industry that was once driven by a PC is now driven by a smartphone,’ said Jim McGregor, an analyst at Tirias Research. ‘‘Dell more than anything changed the business model of the PC market. But when you look at all the innovation that’s gone on recently, it hasn’t been on the PC.”

Photographer: Kiyoshi Ota/Bloomberg

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Photographer: Kiyoshi Ota/Bloomberg

An attendee examines a laptop computer running Microsoft Corp.'s Windows 8 operating system during a launch event in Tokyo.

Michael Dell and Silver Lake will pay $13.65 a share for the PC maker, the companies said yesterday in a statement. Microsoft (MSFT) Corp., a Dell partner whose software runs more than 90 percent of the world’s PCs, is contributing a $2 billion loan to the buyout, which will give Dell more latitude to cut jobs and steer strategy.

Dell’s Heyday

The computer industry is facing its second consecutive decline in annual sales this year while tablets and smartphones continue to surge. PC shipments fell 4 percent in 2012 and will slide a further 1.5 percent this year, JPMorgan Chase & Co. analysts estimate. Tablet unit sales, by contrast, rose 72 percent last year and will surge 54 percent this year, they project.

Dell’s rise from dorm-room startup to more than $100 billion market-value company in the middle of the last decade exemplified a time when innovation in electronics was focused on the PC. By selling directly to consumers and companies and letting them specify their own components, the Round Rock, Texas-based company helped bring down the average selling price of a PC from more than $2,000 in 1995 to less than $700 in 2011, according to market-research firm IDC.

IBM’s Path

In the process, Dell elbowed aside the industry’s founder, International Business Machines Corp. (IBM), contributing to that company’s exit from the business in 2005 in a spinoff to Lenovo Group Ltd. (992) Freed of the commodity PC business, IBM recast itself as a computer software and services company, a move that Dell has tried to replicate through acquisitions.

IBM now gets about 80 percent of its revenue from services and software, helping its gross margin -- a measure of profitability that equals the percentage of sales left after deducting production costs -- reach 52 percent in the most recent quarter. That’s more than twice the gross margin at Dell, which still relies on PCs for half of its revenue.

The past two years are littered with examples of a changing of the guard among the companies that dominate technology. Qualcomm Inc. (QCOM), the largest maker of chips that run phones, unseated Intel Corp, (INTC) the No. 1 provider of processors for PCs, as the biggest U.S. chipmaker by market capitalization.

Mobile Era

With the emergence of tablets and smartphones, PCs now represent just 29 percent of all Internet-connected devices, according to a December report by Goldman Sachs Group Inc. That means that Microsoft, whose operating system ran 97 percent of computing devices in 2000, now has just 20 percent of the total consumer-computing market. Google Inc.’s Android mobile operating system has 42 percent, and Apple Inc. has 24 percent.

“The bigger question is: Are personal computers dinosaurs?” said Daniel Morgan, a senior portfolio manager at Synovus Trust Co.

What the industry and Dell in particular missed was the shift from corporations to consumers as the drivers of growth in computing, according to Bob O’Donnell, an analyst at IDC. While businesses dominated orders, Dell’s focus on lowering the costs of manufacturing helped it prosper. When innovation in products was needed, the company suffered.

“The design piece was something where they fell behind on,” said O’Donnell. “Dell has kind of gotten in some markets early, but barely dipped their toes in and then backed away. That was true for mobile phones, that was true for tablets.”

Product Flops

Dell’s attempts to fire up consumer interest in PCs such as the Adamo in 2009 flopped when the $2,000 price of the slimline notebook limited sales. The Dell Streak smartphone went on sale in June 2010 and was discontinued the following year. Likewise, the Dell DJ music-file player and iPod rival debuted in 2003, then was withdrawn in 2006.

Dell’s limited efforts contrast with Apple (AAPL)’s success at reinventing itself and becoming the world’s largest publicly traded company. Apple, one of the pioneers of personal computing, now gets less than 15 percent of sales from its Macintosh computer line, while more than 70 percent comes from smartphones and tablets.

“I don’t see them all of a sudden introducing a new product that gets everyone excited,” Synovus’s Morgan said of Dell. “I just haven’t seen much from Dell.”

The lack of appeal to consumers may spill over and hurt corporate PC sales as BYOD -- bring your own device -- accelerates, according to IDC’s O’Donnell. Consumers are increasingly taking easier-to-use iPads and smartphones to work, potentially undermining demand for devices traditionally provided by employers.

Cost Focus

Another constraint on Dell’s ability to innovate was its focus on reducing costs and lower prices, which increasingly drove its business toward lower levels of profitability as Asian manufacturers followed with similar approaches, according to O’Donnell. By choosing to discount and manufacture cheaper rather than improve designs, PC makers became involved in a “race to the bottom,” which Dell is no longer winning.

Dell, once No. 1 in PCs, lost the industry crown to Hewlett-Packard Co. (HPQ) in 2006, and Lenovo leapfrogged it to take second place in 2011. Dell is now third with 10.7 percent of the 352.7 million-unit market in 2012, after suffering a 12 percent shipment decline, the largest drop among the top five producers, according to Gartner Inc.

And while Hewlett-Packard has returned to the top spot, that company is also struggling because of its failure to crack the tablet or phone markets, after its acquisition of Palm Inc. didn’t produce products that companies or consumers wanted. Hewlett-Packard saw PC shipments decline 6.7 percent in 2012 and has considered divesting the unit.

Cash Engine

Dell, meantime, isn’t likely to shed PCs anytime soon. It relies on the division, which provides about half of its revenue, to generate cash needed to make payments on the debt incurred to buy out shareholders, said Abhey Lamba, an analyst at Mizuho Securities USA Inc.

“They would need to continue running the PC business to generate a certain threshold of cash, and the PC industry is increasingly getting commoditized,” said Lamba. “The thing with a commodity business is you lower cost by getting scale, and you get scale by lowering price, so it’s a vicious cycle.”

To contact the reporters on this story: Ian King in San Francisco at ianking@bloomberg.net; Dina Bass in Seattle at dbass2@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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