(NASDAQ: DELL)-Will Microsoft’s $2 Billion Dell Investment Play out like its Partnership with Nokia?

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(NASDAQ: DELL)-Will Microsoft’s $2 Billion Dell Investment Play out like its Partnership with Nokia?

Summary: Microsoft (NASDAQ: MSFT) has agreed to sink $2 billion into the Dell buyout deal, ostensibly in a bid to retain strong ties with its OEM partner Dell and have some control over the firm’s planned restructuring. If, however, Dell’s partnership with the giant software maker plays out like its partnership with Nokia, other PC makers have little to fear.

Dell (NASDAQ DELL) is at a critical turning point in its 29-year history. Never before in its existence has the revered PC maker, the 3rd largest in the world with an 11.8% market share after Lenovo (HKSE: 992.hk) in pole position with a 16.7% market share and HP (NASDAQ: HPQ) in 2nd place with a 16.3% market share, according to a June report by the Gartner Group, faced such a tough test as it is facing right now with its planned privatization.

That Dell needs to privatize is a foregone conclusion; it is the only way that Michael Dell, the eponymous Dell founder, will get a free rein to drastically restructure the company from a PC and device manufacturer to a solutions provider. Dell right now looks like the IBM (NASDAQ: IBM) of old. Both companies were respected PC and related hardware titans until the winds of change came blowing hard. IBM responded to tightening hardware margins by transitioning itself from its mainstream hardware business to a ‘‘services and solutions’’ business. Its greatest milestone was achieved in 2004 when it sold off its PC business segment to China’s Lenovo.

Dell has, however, so far not succeeded in shaking off its PC-manufacturer image. The company has since 2008 spent billions of dollars in acquisitions of companies such as AppsAssure, SonicWall and Quest Software and now brands itself as a cloud computing, management software and converged infrastructure data centers company. The PC manufacturer tag, however, still lingers and refuses to go. Consider that Dell’s shares closed the day trading at $13.14 on Friday 20th July 2013, way below the $30 range they traded in late 2007 and much lower than the $54 recorded before the burst of the Dotcom bubble. A radical restructuring is the only way Dell is going to reinvent itself hence Michael Dell’s decision to take the company private.

Microsoft (NASDAQ: MSFT) will sink $2 billion in the form of a loan to Dell in the planned $24.4 leveraged buyout. The immediate short-term effect of the partnership will be that Microsoft maintains a strong say in Dell’s affairs, one of its key Windows customers. It is quite instructive to note that Microsoft did not invest billions in equity as earlier anticipated, but instead opted for loan financing. The move was seen as Microsoft’s way of playing it safe by investing in less-risky debt that would cover its tails in case Dell flounders during the transition. By investing in debt rather than equity, Microsoft also tried to perform a delicate balancing act by keeping its entire PC ecosystem happy and avoid looking like it was playing favorites.

Microsoft strained its ties with PC manufacturers last year by releasing its Surface Tablet that competes directly with PCs. Its strategic investment in Dell could further exacerbate strained relations with PC manufacturers if they see it as giving unfair advantage to Dell. Microsoft is keen to keep its principle operating systems customers in the pink of health, especially in the wake of severe competition from the likes of Linux and Google (NASDAQ: GOOG).The $2 billion loan is quite significant for Dell since there were serious concerns whether the giant PC maker would have been able to get that much from the debt market.

Situation Reminiscent of Nokia Deal

Microsoft paid out billions of dollars to Nokia (NYSE: NOK) in a rescue bid to keep the mobile phone manufacturer that was teetering on the edge from bawling over. The Nokia-Microsoft deal was consummated in February 2011. Microsoft’s investment in Nokia was widely seen as a way of locking in Nokia with Microsoft’s Windows Phone platform, and keep out competing OSs such as Android. In the Dell-Microsoft deal, Microsoft is probably trying to keep Dell from straying into enemy camps such as Chrome OS, Linux and Android.

When you scrutinize the deal further, another interesting parallel appears. During the Nokia deal, there was plenty of chatter about whether the partnership would result in an unfair advantage for Nokia. There are similar concerns of whether the Dell deal will give the PC maker an unfair advantage, such as gaining access to an early look into new Microsoft software and an unfair preference in  product promotion. But how real are these concerns? Let’s have a peek at the much publicized Nokia-Microsoft partnership.

Just how well has the Nokia-Microsoft deal played out thus far? Not too well I dare say. Nokia was expected to contribute its expertise in language support and hardware design to help bring Microsoft’s Windows Phone to more diversified price points ranges as well as larger geographies and market segments. Investors, however, saw the move as relegating other Windows Phone partners such as HTC, Samsung, and, even Dell, to second-class partners in the Windows Phone ecosystem. Microsoft came out of the gates after the deal was done with its guns blazing, pushing Nokia’s Lumia as the flag carrier for the Windows Phone platform. Since then, Microsoft’s ardor for Nokia’s Lumia has cooled off somewhat, and they now share the love with other non-Nokia Windows Phone manufacturers as well. It is not uncommon to see Microsoft’s own managers sporting the trendy HTC 8X Windows Phone as opposed to the Nokia Lumia. In fact Microsoft identifies HTC as its signature Windows Phone partner. HTC even uses Windows Phone in its official name, something Nokia never did.

 

Microsoft recently chose to go with Huawei in its 4 Africa African-Development initiative instead of Nokia as many industry insiders had expected. This despite Nokia’s proven track-record in selling phones in emerging markets and developing countries. In February 4th this year, Microsoft together with Huawei jointly unveiled a new variant of Huawei’s Windows Phone 8 Ascend W1.

 

Enterprise Software Services Much More Profitable

 

Dell’s operating margins currently stand at 5.74%.Compare that to the more than 36% operating margins Microsoft derives from selling bundled software. Microsoft can potentially influence more software sales by way of the Dell legacy business. But this does not in any way negatively influence its other OEMs. Going by the way the Nokia-Microsoft deal has played out so far, other Microsoft PC OEMs need not worry that the Dell-Microsoft deal will give unfair advantage to Dell. In fact, Dell might only end up as a factory for Microsoft’s Surface Tablets and PCs or just a stronger Windows OEM partner for Microsoft. If Dell does succeed in transforming itself into an enterprise IT services provider, it will gel beautifully with Microsoft, whose enterprise software services division is amongst its most robust and rapidly growing business segments. But this won’t threaten other Microsoft OEMs in any foreseeable manner. It is a tumultuous time, no doubt, to be one of Microsoft’s OEMs right now. With the rapidly declining PC market (down 10.9% in Q2 2013), it will be interesting to see how many Windows OEMs will still be in existence a few years down the line, or how many will still be backing the Windows platform in a bid to hedge their bets.


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