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Here’s The Secret Private-Equity Plan For Dell

Earlier, I wrote about what Dell was likely to do now that it is taking itself private.

I suggested that Michael Dell and his private-equity backers would coin money, in part by paying themselves a huge one-time dividend with the cash sitting on Dell's balance sheet.

I also bemoaned the fact that Michael Dell had to take his company private to coin this money instead of executing his plan as a public company and sharing the loot with his current shareholders.

More broadly, I complained that too few public-company management teams (like Dell's) have the balls to tell short-term public-market investors to take a hike and implement long-term strategic plans.

And that is indeed a bummer.

But it's also the reality.

Most public-company management teams are so cowed by Wall Street's short-term demands that they sacrifice the vision and cojones that enabled them to build big public companies in the first place. And then they just manage their companies from quarter to quarter while avoiding the tough, ballsy decisions that separate great companies from good ones.

Anyway, Dell has decided to go private.

So the questions are:

  • Why is Dell going private?
  • What is Dell going to do as a private company?

Earlier, I speculated about what a generic private-equity firm might do with Dell after taking it private.

I have since spoken with sources familiar with the specific Dell situation. So I have some better information.

Here's what the sources told me:

  • Dell is going private because the company is in the middle of a 5-year transformation from "PC manufacturer" to "single-source provider of corporate cloud and security solutions" (sort of a mini-HP or mini-IBM model) and the market is giving it no credit for that transformation. The company feels it has been making good progress on its transformation, but management is worried about meeting quarterly targets and other milestones that are slowing the transformation down. And the stock just keeps dropping. So Michael Dell and Silver Lake felt there was an opportunity to be bolder and more aggressive with Dell as a private company.
  • Silver Lake and Michael Dell are borrowing about $17 billion of the $24 billion Dell purchase price ($15 billion from banks and $2 billion from Microsoft), which means they are temporarily putting up about $7 billion of equity capital. Dell has $15 billion of cash sitting in the bank. So it seems highly likely--we'll know in 45 days, when the SEC filing appears--that Silver Lake and Dell will pay themselves a big dividend to cover their cash investment. After that point, they'll be playing with house money. (Correct--it doesn't suck to be in the private-equity business!).
  • The secret plan for Dell is NOT to fire thousands of people and chop the company up and sell off the parts. Sure, some folks might get fired and some divisions might get sold. But the plan is to invest in the company's product suite, R&D, pricing*, and marketing capabilities, thus accelerating Dell's transformation into a solutions provider. This investment will temporarily reduce the company's free cash flow and profits, which public-market investors might (stupidly) have freaked out about. This was one of the reasons Michael Dell wanted to take the company private.
  • Dell's plan is to focus on selling its solutions to mid-market companies (~500 employees), not the gigantic Fortune 500 companies that are already well-served by IBM, HP, and other huge "solutions" providers. By providing comprehensive solutions for cloud and security to companies that are not currently well-served, Dell also hopes to increase demand for PCs at these companies--PCs that Dell will obviously provide.

The private-equity firm backing Dell, Silver Lake, has a long history of investing in troubled tech companies, and it has posted excellent returns over the years. Silver Lake's target investment time horizon is about 5 years, which is about 100-times longer than the time horizon of the typical public-market investor. So Silver Lake is willing to depress Dell's earnings and cash flow for a couple of the years while investing heavily to transform the company--thus, hopefully, creating a more valuable Dell over the long term.

That said, Dell's competitor HP is not so optimistic and had these crushing statements about Dell's turnaround:

"Dell has a very tough road ahead. The company faces an extended period of uncertainty and transition that will not be good for its customers. And with a significant debt load, Dell's ability to invest in new products and services will be extremely limited. Leveraged buyouts tend to leave existing customers and innovation at the curb. We believe Dell's customers will now be eager to explore alternatives, and HP plans to take full advantage of that opportunity."

Public market investors and wimpy management teams take note: Your obsession with quarterly performance creates the opportunity for firms like Silver Lake to come along and buy your companies on the cheap, thus coining money for their private-market investors. In short, your quarterly earnings obsession is ruining companies and destroying value. So grow a pair, tell Wall Street to be patient, and focus on creating value for the long term!

* What I mean by "investing in pricing" is cutting prices on hardware and, thus, reducing profit per unit. This will hurt profit margins but make the company's solutions more attractive to customers. And given that the focus is now on "solutions," they'll be looking to sell the hardware at closer to cost and then make money on add-on software and services.

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