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Dell’s Software Binge Continues

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Dell Inc. (NASDAQ: DELL) is one of the most recognizable hardware companies in the PC space but has recently turned its attention toward conquering software and services. On March 5, the company appointed John Swainson as the head of their newly formed software group and began acquiring software companies at a breakneck pace. The company has already acquired multiple software companies and the pace has accelerated with three acquisitions coming this week. In the past months Dell has acquired an array of software companies including:

  • AppAssure – provides backup software for cloud, virtualization, and physical infrastructure
  • Clerity Solutions – modernizes applications and moves them off existing infrastructures
  • Make Technology – updates applications, modernizes code, and seeks to cut maintenance costs
  • SonicWall – makes firewall and security software
  • Wyse Technology – specializes in desktop virtualization allowing remote access to applications and documents stored on a remote server

All five recent acquisitions have a connecting thread: the cloud. Together they give Dell the ability to sell a company an entire array of services designed to update their infrastructure and move it safely to the cloud.

The increased spending highlights a remark from Dell CFO Brian Gladden, who in February pointed out a need for increased R&D spending and that some of it would come in the form of asset acquisition. R&D has been a weak point of Dell’s, particularly when compared to two of its biggest competitors, Hewlett-Packard (NYSE: HPQ) and IBM (NYSE: IBM):

  • IBM spends about 6 percent of revenue on R&D
  • HP spent 2.6 percent of revenue on R&D in the quarter ended Jan. 31
  • Dell spent just 1.5 percent of revenue on R&D for the year and just 1% the previous year

Though the specifics of the recent acquisitions have yet to be made public, it is safe to assume the increased spending will expand overall R&D for software and services.

Dell isn’t in dire straits, but the new direction can boost the company’s bottom line in two ways: greater access to a high-growth market and another selling point for their existing hardware. Even though global PC shipments declined last year and are expected to have tepid growth through 2016, server revenue growth has been a bright spot for Dell. In Q4 of 2011 global server sales fell 5.4 percent, but Dell managed to pick up additional revenue and market share. Anything else that strengthens their performance is welcome, particularly in light of the recent decline in PC sales. Added revenue from software will add much-needed growth and has the bonus of being independent of hardware sales.

Rival IBM underwent a similar shift toward service and software and may serve as a blueprint for Dell’s new strategy, though it is unlikely Dell will get rid of their bread and butter consumer line. It is worth noting that even though IBM has put a bigger emphasis on software, its server business has thrived. IBM shipped the third most servers in 2011 and managed to hold the number one spot in server revenue. This indicates IBM is avoiding price competition, which may be due to the value added by its software and services -- certainly an enticing prospect for Dell. Dell’s shift from being just a hardware company was spurred by the higher margins offered by software and services; expanding margins in its server line would be an added bonus.

The company has struggled in the fastest growing portion of computing -- the mobile market. Mobile computing has displaced traditional PC sales in some cases, leading some to label it the end of the PC era, which doesn’t bode well for Dell. Dell hasn’t had much success, discontinuing several failed efforts, but the company hasn’t given up completely. Microsoft’s (NASDAQ: MSFT) Windows 8 is due later this year and could prove to be the catalyst Dell needs in mobile. Dell’s CEO Michael Dell has said previously that he believes Windows 8 will be the best chance to compete with Apple (NASDAQ: AAPL) and its iPad. The iPad dominates the consumer space, but has been less successful in the business. An enterprise-focused tablet from Dell has the potential to be a real revenue driver, particularly if Windows 8 lives up to expectations. Dell could leverage its newly purchased cloud expertise into a corporate tablet that is tailor-made to work with its cloud infrastructure, which could easily be a major selling point. It could as easily become an add-on to their existing products, offering an additional revenue stream and another point of differentiation for their products.

Despite their recent software binge, Dell remains a PC company and that’s ok. The PC isn’t dead yet and Dell’s recent actions are putting it in a position to reach beyond its PC roots. As I pointed out earlier, Dell’s acquisitions have had a cloud-focused tilt, which should pay dividends in the long run. Cloud computing remains a high-growth area and embracing it is a positive for Dell. The only drawback is the increased competition, but Dell has performed well in the face of competition before. The recent acquisitions should go a long way toward establishing Dell’s software group and gives it the potential to become a significant revenue driver.

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