Saturday, April 20, 2013

For Dell, the future ain't what it used to be

Thursday’s decision by Blackstone’s private equity partners to give up on buying Dell marks the end of an era.

The failed bid is an important story on many levels. I'll ignore for now the temptation for schaudenfreude after Michael Dell’s faulty prediction 15 years ago that Apple was worthless and should be liquidated. (Friday’s closing market cap: Apple $367 billion, Dell Inc. $23 billion).

Let’s also ignore that the end of the Blackstone bid appears to assure the success of Michael Dell’s $13.65/share offer to buy Dell Inc., funded by Silver Lake Partners. With this, shareholders must set aside very real concerns about Mr. Dell’s proposed buyout, particularly the conflict of interest from a CEO-founder who IPO'd his company and now wants to buy it back after the shares have fallen 2x since he returned as CEO in January 2007.

Instead, let me focus on two key insights Friday — from stories Friday by Bloomberg and the Wall Street Journal — on the real story on why the buyout collapsed.

The first reason was the collapse of the PC industry. As the Blackstone notice to Dell Inc. remarked (as quoted by the New York Times):

While we still believe that Dell is a leading global company with strong market positions, a number of significant adverse issues have surfaced since we submitted our letter proposal to you on March 22nd, including: (1) an unprecedented 14 percent market decline in PC volume in the first quarter of 2013, its steepest drop in history, and inconsistent with Management’s projections for modest industry growth; and (2) the rapidly eroding financial profile of Dell.
Or as IDC reported on April 10:
Worldwide PC shipments totaled 76.3 million units in the first quarter of 2013 (1Q13), down -13.9% compared to the same quarter in 2012 and worse than the forecast decline of -7.7%, according to the International Data Corporation (IDC) Worldwide Quarterly PC Tracker. The extent of the year-on-year contraction marked the worst quarter since IDC began tracking the PC market quarterly in 1994. The results also marked the fourth consecutive quarter of year-on-year shipment declines.
The second reason was the rapid collapse of the financial prospects of Dell Inc. To quote from the WSJ,
Another issue, some of the people said, was a seeming freefall in Dell's forecasted operating income. While some Blackstone executives initially had hoped the predictions were worst-case scenarios, in due diligence they concluded the predicted outcomes were spot on, and the numbers could come in even lower, the people said.

Dell, in the March 29 filling, predicted adjusted operating income of $3 billion for the fiscal year ending next January—a stark contrast to the $5.6 billion the company had predicted the previous July.
Dell hoped to diversify into other areas, but that has failed. As the Bloomberg story reported: “the enterprise-solution business, heralded by analysts as Dell’s future, was years away from competing meaningfully in that market…”

In other words, we’re at the tail end of the PC era. Although it’s coming more rapidly than expected, the outcome is as predictable as it was for bookstores, record stores or newspapers. Dell had hoped to diversity its way out of the problem, but so far those efforts have failed.

The implications seem as bleak for the rest of the PC industry. As part of a “Dogs of the Dow” value investing strategy, I own a few hundred shares of Intel, which has gone nowhere in the past two years. Microsoft has done only slightly better, due to hopes (IMHO unfounded) that it will someday benefit from the shift to smartphones and tablets. Even Apple has major exposure to personal computers, where it has been gaining share as its tablet share (but not unit sales) has fallen.

More significantly, in the late 20th century Dell was the winner of the commodity PC industry, but then was out-commoditized by Mark Hurd at HP. Right now the commodity business is going badly for both.

From 1960-2000, we saw the collapse of the mainframe, minicomputer and workstation industry. It wasn’t the low-cost firms that survived to the bitter end, but the high value-added ones. The others morphed into something else (NCR: ATM machines; Burroughs and Univac: IT services), exited or died.

Given that HP and Dell have negligible presence in the most rapidly growing computing segments — smartphones and tablets — what’s left 10 years from now will be two very different companies. HP’s done a better job of diversifying than Dell, but neither’s prospects are terribly attractive.

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