4 Reasons Dell Will Be Acquired
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Dell (NASDAQ: DELL) saw a huge move today on speculation that it has had several discussions with firms about a potential buyout. The stock increased by 12.96% and is up an additional 3.5% in after-hours trading. While most are still trying to wrap their heads around the possibility of a Dell takeout, I will list 4 reasons this makes sense for Dell.
Reason #1 - Cheap Valuation
Even after today's large share price increase, Dell only has a PE ratio of 8.37. This is vastly superior to several of its main competitors such as Apple (NASDAQ: AAPL), Cisco Systems (NASDAQ: CSCO), NCR (NYSE: NCR), EMC (NYSE: EMC), and Canon (NYSE: CAJ). Here are their respective PE ratios:
- Apple: 11.36
- Cisco: 13.53
- NCR: 28.33
- EMC: 19.84
- Canon: 15.89
It is clear that Dell is undervalued relative to its computer and software peers. One reason these other companies may have slightly higher valuations is that they have diversified their business models away from just the personal computer space.
- Apple is more than just the Mac computer. It is involved in consumer products that span from tablet devices to phones to personal music players.
- Cisco is a little different from Dell. Instead of focusing on the hardware sales to consumers, it is focused on the behind-the-scenes work. It provides connectivity to end users, workstations, and IP networks for mobile, data, voice, and video applications.
- NCR focuses more on software solutions than does Dell. In addition to software, it also provides consulting services to various vendors across the marketplace.
- EMC focuses on data storage and offers enterprise systems and software.
- Like Dell, Canon is focused on direct selling to consumers. But instead of manufacturing and selling personal computers, it focuses on office equipment like printers and copiers, and also has a large market share of the camera market.
A common thought is that Dell has the ability to diversify like the above companies, but it will take time and patience to do so. These are the types of situations that private equity firms are very interested in. Dell has already solidified its place in the market with its strong brand. And with a valuation that appears out of line, this might be the perfect time for some firms to come knocking at Dell's door.
Reason #2 - Strategy Shift
It is clear that Dell will need to shift its focus away from personal computers and focus more on the niche markets, like tablet devices. Brian White, an analyst at Topeka Capital Markets, thinks that Michael Dell would prefer to do this as a private company. This would allow the company plenty of breathing room to make the necessary adjustments without the shining spotlight of the stock market. This has worked for many companies in the past as the deal allows the acquired company time and additional resources to make the shift, refocus energy, and return to the market as a new and improved company.
Reason #3 - Strong Cash Levels and Free Cash Flow Generation
When private equity firms are interested, their preferred method of transaction is the leveraged buyout deal. In this type of deal, commonly known as an LBO, the PE firm will borrow almost all of the money, and then use the company's excess cash and cash flow generation to pay down the interest on the debt. Now it also so happens that we are in a time of extremely low interest rates, which makes the deal even more appealing to these private equity firms.
At this point in time, Dell has $5 billion in net cash. Also, for the 2012 fiscal year, Dell was able to generate over $5.5 billion in free cash. This is an area that PE firms will scrutinize as the intent is to use this cash to pay down their borrowed amount to complete the deal. Dell appears to be in fine shape here.
Reason #4 - Blackstone Group (NYSE: BX)
Although it has been widely reported that Silver Lake and TPG may team up to take Dell private, I think a more likely suitor might be The Blackstone Group. Roughly a week ago, Dell's head of mergers and acquisitions, Dave Johnson, left the company to join the private equity division of Blackstone. Now that might be a coincidence that a week after the head of Dell's mergers group leaves, news outlets begin reporting that Dell might be in talks to be taken private. But I have to admit that that would be the coincidence of the century. A more likely scenario is that Johnson transitioned over to Blackstone to help cement the deal and help bring Dell to the next phase of its growth cycle.
The above 4 reasons make a very compelling case for why Dell can and should be taken private. Of course, this is all still speculation. But with the stock trading up almost 13% today, and trading higher after hours, it appears that the market is warming to this idea.
Fool blogger Michael Meyer is short January puts in Dell. Options carry a great degree of risk and should only be traded after a suitability test with their financial advisor. Options can result in entire loss of premium and account value. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!