Feb. 6 (Bloomberg) -- Now that Michael Dell has clinched a deal to take his company private, he faces the bigger challenge of turning a business falling behind in personal computers into a provider of high-margin cloud-computing tools and services.
Dell, 47, gains greater freedom to cut jobs and embark on strategy shifts at Dell Inc. without answering to public shareholders. Still, the buyout imposes constraints, including saddling the company with $17 billion in debt. Interest payments will eat up cash that could be spent on acquisitions and research and development to take on International Business Machines Corp., Hewlett-Packard Co. and Oracle Corp. That may also force Dell to keep the PC division, which drags on margins.
“It’s a double-edged sword,” said Bill Whyman, an analyst at ISI Group. “They don’t have the balance sheet to go up against IBM, HP or Oracle. Those companies spent billions of dollars to change the mix of their businesses.”
Michael Dell and Silver Lake Management LLC are taking the Round Rock, Texas-based computer maker private in a transaction valued at $24.4 billion. Dell is regaining majority control of the company he started in an university dorm room, and will remain chairman and chief executive officer.
A quarter-century after its debut as publicly traded company, Dell’s in a tough spot. The PC maker has spent $12.7 billion to buy 18 companies since 2009, including Compellent Technologies Inc. in data storage and Force10 Networks Inc. in networking. Yet Dell isn’t bundling enough of those highly profitable products with the computer servers it sells. That would help it better cope with a PC sales slump.
In software, a $1.5 billion business, Dell needs to make a bigger splash in cloud-computing tools for companies managing fleets of servers, networking gear, and business applications online, without hiring teams of expensive consultants. That could help Dell sell more software to mid-sized companies and enterprises seeking streamlined ways to manage their data centers, a $9.9 billion market occupied by heavyweights including IBM, Microsoft Corp., and VMware Inc.
By going private, Dell could draw up a new playbook less contingent on satisfying shareholders. It can take steps to invest in the future, and emerge as a stronger company less reliant on PCs and able to claim a bigger slice of the technology industry’s profits.
A closely held Dell would also save an estimated $556 million a year in dividend payments. It could use that money for severance payments and restructuring costs.
Without access to public-market capital, buying upstart firms with compelling technology becomes harder. Financing debt will also skim an estimated $1.2 billion a year, according to data compiled by Bloomberg. Dell’s debt burden could increase if interest rates rise.
Lower credit ratings would also push financing costs higher. Moody’s Investors Service lowered Dell’s senior unsecured rating yesterday to Baa1 from A2, and Fitch Ratings cut Dell’s long-term default rating to BB+ from A. Standard & Poor’s put Dell’s A- minus rating on negative watch.
The cost of servicing debt after the buyout over the next three years will be about the same, or slightly less, than Dell’s dividend and share repurchase costs over the past three years, the company said in a filing yesterday with the U.S. Securities and Exchange Commission.
One of the people likely to play a key role in reshaping Dell is Marius Haas, recruited in August after Michael Dell pressed him to join. A 45-year-old Dutch national, Haas arrived after a year as an adviser at KKR & Co., and previously led mergers and acquisitions at Hewlett-Packard under former CEO Mark Hurd.
Haas is trying to inject Dell with more urgency to pair storage and networking gear with the growing server business. Selling 2 percent more of high-margin gear with servers would add $1.2 billion in annual sales, said Haas, who says storage and networking products yield gross margins of 30 percent to 60 percent, compared with 22 percent for all of Dell.
Haas said he’s been negotiating with Hurd, now Oracle’s co-president, to get more Oracle database sales to run on Dell machines. About 60 percent of Oracle currently runs on Hewlett-Packard servers.
“I would love to change that to 60 percent for Dell,” Haas said. “Mark and I are very incented to work together.”
The enterprise efforts have paid off so far, with Dell emerging as one of the world’s biggest makers of servers used to run websites, process financial transactions and analyze reams of business data. During the third quarter, Dell sold about 565,000 mainstream Intel-based servers, according to Gartner -- just 65,000 less than market leader Hewlett-Packard.
Dell is poised to be No. 1 this year in the server market, CEO Dell said at a customer conference in December, giving the company a broad platform to pitch customers on its storage and networking products.
Gaining a larger share in enterprise computing won’t be a slam dunk. A sizable portion of the server market has evaporated in recent years as huge volume customers such as Google Inc. and Facebook Inc. buy directly from no-name manufacturers such as Quanta Computer Inc.
While putting more emphasis on data centers, Dell will need to grapple with what to do with PCs, an ailing division that accounts for about half of sales, according to Shaw Wu, an analyst at Sterne Agee & Leach Inc.
Within the PC market, Samsung Electronics Co., Lenovo Group Ltd., and Asustek Computer Inc. are challenging Dell at the lower end of its business, while demand for Apple’s iPads and higher-end Macs remains buoyant.
“As we’ve seen through history, it’s tough to win a two-front war,” Wu said.
Withdrawing from the scrutiny of public markets may be Michael Dell’s gambit to restore his reputation as a technology pioneer. He founded Dell at 19, took it public at 23, and was worth $1 billion eight years later. The company’s woes have cast him from a industry pantheon that includes Apple’s Steve Jobs, Microsoft’s Bill Gates and Oracle’s Larry Ellison. Going private -- with the goal of re-emerging as a stronger company later -- could let Michael Dell prove naysayers wrong.
“Before this agreement, the company’s core PC business was deteriorating more than its new enterprise businesses and the net effect was weak revenue growth,” Shebly Seyrafi, an analyst at FBN Securities in New York, said in a telephone interview. “Now they have that opportunity to be more aggressive and flexible, fix things and turn it around.”
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