Dell - Finding Method in Madness

He started his first business publishing lists of stamps that he auctioned and shipped by mail, pulling in an impressive $2,000 without big startup costs at the age of 13, to the amazement of his orthodontist father and stockbroker mother. As a teenager, he industriously combed county archives to find the addresses of recently married couples and sold newspaper subscriptions to them, as he believed they had an inclination to subscribe. At such a nascent stage, he knew how to identify his audience in a business.

At 16, he had saved enough to buy an Apple II, which he dismantled to study its mechanics. Following his natural calling, from a dorm room at the University of Texas in 1983, he created a company that delivered the first PC to millions of Americans, employing the mantra of faster, better, and cheaper.

Over the coming years, he would go on to list his PC company on the public markets, making it a multi-billion-dollar company; retire, and then come back from retirement to take the business private, marking the largest technology leveraged-buyout (LBO) transaction at the time; piling up debt to accelerate growth and then acquiring a listed IT infrastructure giant to achieving a sustainable business model. He was 23 years old at his company’s IPO in 1988, 5 years younger than Mark Zuckerberg at the same milestone. He was just 29 when his company hit $1bn in revenue and just 31 when it hit $5bn.

Amongst the Silicon Valley skeptics and Wall Street adversaries, he pulled off the deal of the century, borrowing and flipping his way to a $50bn fortune. He is… Michael Dell.

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Dell’s humble beginnings

After Michael Dell started selling computers out of his dorm room, he decided to drop out, to focus on his business, which was called “PC’s Limited." This was the birth of the Dell empire. In 1985, PC’s Limited created a 10-MB PC, the Turbo PC, with a price tag of $795, undercutting IBM’s costlier machines. Michael Dell took on HP and IBM as a college freshman simply because he was willing to assemble PCs himself and sell them directly over the phone.

Very shortly after incorporation, in June 1988, at age 23, Michael Dell took his company public and became a multimillionaire, selling $30m in stock. It is now when the company decided to rename the company from PC’s Limited to Dell Computer Corp. Dell was valued at $85m and the shares made a debut at $8.50-per-share.

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The Rise of Dell PCs

Post listing, for a decade, Dell saw tremendous growth globally as it steadily set up subsidiaries in Britain, built manufacturing centers in Texas and Ireland, and expanded its footprint to Asia, Japan, Europe, and other parts of the Americas. Dell hit $1m in daily sales in 1996. In 2001, after a decade of skyrocketing sales, Dell became the world’s largest seller of personal computers and hit a peak market cap of $100bn.

According to International Data Corporation (IDC), Apple shipped the most PC sales worldwide in 1990; followed by IBM from 1991 to 1994; and then Compaq held the lead from 1994 through 2000. Finally in the first quarter of 2001, for the first time in about seven years, the rankings shifted as Dell Computer surpassed Compaq to become the world's largest PC maker. Dell had a 12.8% market share worldwide. Compaq was a close second at 12.1% market share.

In 2002, when HP merged with Compaq, it reclaimed the No.1 spot in PC sales from Dell. The new HP giant constituted 18.4% of the market vs. Dell at 13.2% (5% difference between the Top 2 players). In 2002, the gap between #1 and #2 narrowed, as the new HP giant led the way with a 16.2% market share, but its sales fell by 9.3%. On the other hand, Dell was the striking exception in the 2001 downturn when the worldwide PC market declined by ~5%, as Dell posted an impressive 18.3% surge in sales, while all other leading vendors saw double-digit declines. Dell captured a 15.2% market share, just 1% behind the HP-Compaq group now.

In 2003, Michael Dell invented a new business model for the industry: Build computers to order and fill orders by operating a highly automated and digitized supply chain. This was called the Build-to-order supply chain, which bore lower costs for Dell, as it didn’t need to maintain any PC inventory. Amidst an industry-wide decline in PC prices, Dell could further afford to sell their PCs at dirt-cheap prices to further gain market share and eventually regain its top spot from the HP-Compaq giant.

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The Fall

Things were going well for Dell. Dell was an unstoppable force in the PC industry from 1997 through 2004 and consistently gained market share from its competitors--even during slumps in the industry. With this, Michael Dell decided to retire in 2004 to focus on his philanthropic foundation but retained the Chairman position. President and COO, and former Bain consultant Kevin Rollins was handpicked for the role of the CEO.

And it was then that things started to slip: customer service, product quality, strategy, and vision.

• Dell’s results missed Wall Street expectations for several quarters
• Failed to see the massive industry shift from desktops to notebook PCs. Dell had managed to convince consumers that it had the lowest-priced PCs on the market. However, its price advantage was tied heavily to its ultra-efficient manufacturing process for desktop PCs. That advantage became less important as the market began to shift in favour of notebooks.
• In 2006, a battery recall was caused after a Dell laptop caught fire. Rollins invested $150m in customer service improvements, but the company waited too long to sense the growing dissatisfaction with its products and customer service.
• An investigation by the SEC for possible accounting improprieties began
• Several executives had left the company, including the CFO
• Failed to recognise the growing demand for Advanced Micro Devices processors

The Wall Street wanted Kevin Rollins out of Dell!

In 2007, Rollins resigned and Michael Dell returned as CEO to build the "Dell 2.0". Although Rollins was not entitled to severance or a pension plan, he still walked away with stock options worth ~$48.5m earned during his tenure and a hefty severance of ~$5m.

The Return of Michael Dell

“It feels like 1984 and I am starting over again. Only this time I have a little more capital.” – Mr. Dell

Dell needed to expand its software, networking, security, and services offerings. Easy solution? Dell went on a $13bn buying spree, consuming more than 20 firms, the biggest of which was the 2009 takeover of IT services provider Perot Systems for $3.9bn.

• 2009: Acquired Perot Systems for $3.9bn, at a 68% premium, to drive end-to-end IT services
• 2010: Acquired companies in storage, systems management, cloud computing, and software: Boomi, Exanet, InSite One, KACE, Ocarina Networks, Scalent, and Compellent
• 2011: Acquired Secure Works, RNA Networks, and Force10, for enterprise capabilities
• 2012: Another half a dozen acquisitions including storage protection company Credant Technologies and software manufacturer Quest Software

But it wasn't enough. Dell was slow to the shifting IT tides as well. Other tech giants at the time, including HP, IBM, Cisco, and Oracle, were already diversifying to grab market share from one another's businesses. The pace of transformation was demotivating. In Jun-12, shares which were trading above $40 in 2005, had sunk below $12.

Apart from acquisitions, Dell also took other initiatives to revive the business –

• Introduction of Channel Partners: Dell started and built its name selling direct till 2008 and had more than 140,000 channel partners in 2013 generating ~$16bn of Dell's total annual revenues of $60bn, up from zero in 2008.
• Cross-selling: Every 2 out of 3 Dell customers were PC customers at the beginning, and about 90% of those customers further bought other products and services. The sales specialists with technical training had doubled in the last 4 years and had deep expertise in cross-selling.
• Organisational Structure: Switch in the "superstructure" of Dell, from one organized around customers (consumer, small business, public and large enterprise), to one built around the four operating units (PCs, services, software, servers, and storage) supported by one central sales organization.
• Introducing New Products: Dell launched the mobile phone “Mini 3i” in China in 2009; and launched the 5-inch tablet “Streak” in 2010
• Back to thrifty old days: Dell was famous for charging employees for their coffee. A tradition that dates back to Dell’s first $1m sales day, was celebrating with cupcakes in Santa Clara. However, even on those days, everyone got a cupcake, but "just one."

But what was more demotivating was the investor community. Dell’s headlines focused on shrinking PC sales and market share, rather than on the fact that it had steadily built the non-PC business from $10bn to a "pretty impressive" $21bn in five years. Dell had more than five years to lead a turnaround and failed. Shareholders had seen a negative 43% return since Micheal Dell reclaimed the CEO job. So… what next?

(This article contains references to one of the previous articles I have written – https://www.dhirubhai.net/pulse/public-companies-taking-privatisation-route-anjal-agrawal. Do give this a read before continuing the current article.)

2013 – Orchestrating the biggest buyout coup of all time

The seeds of the coup were first laid in Jun-12. Dell's second-biggest shareholder, Southeastern Asset Management holding a 7.5% stake in Dell, was underwater and saw little upside. But it was willing to roll a chunk of its 7.5% stake, ~146mn shares into a management-owned entity if the takeout price was right. This prompted Michael Dell, the idea of privatising Dell. In Jul-12, Michael Dell was at a tech conference in Colorado in the US, and in the hallway ran into Silver Lake Partner Egon Durban. They met in Aug-12 in Hawaii. Dell reached out to another Hawaii neighbour, George Roberts of KKR, to get his thoughts. Roberts agreed it was possible and wanted to talk about doing it together.

Dell decided it was practicable and alerted the board of his intent to orchestrate the first mega-sized leveraged buyout in the technology sector, an industry known for spending money recklessly and reliant on future cash flows – the exact opposite of what any LBO requires. Irrespective, Michael Dell notified Alex Mandl, the board's lead independent director at the time, about his intentions. He enlisted private equity firm Silver Lake (along with co-head Egon Durban) and KKR to take his company private. KKR, concerned about PC demand, dropped out later, leaving only Silver Lake.

And after announcing his plan to take his company private, armed with his fortune and billions from Silver Lake Partners, he travelled the globe including three trips to China, privately reassuring all stakeholders that Dell was business as usual. But at the advice of counsel, he kept a tight lid on talking about the buyout.

After 25 years of its listing tenure, in 2013, iconic computer maker Dell Inc. agreed to a $24.9bn deal to go private. The $13.65-per-share deal for the world’s third-largest computer maker at the time, involved chairman Michael Dell, private equity firm Silver Lake and Microsoft. It became the largest technology leveraged buyout ever, and also the largest company in terms of revenue to go from public to private.

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Deal details

Buyers:

• Michael Dell, Silverlake, Microsoft, and a consortium of lenders
• In addition to Dell's $750mn in cash (and 16% ownership), Silver Lake put up $1.4bn, banks including Bank of America, Barclays, Credit Suisse, and RBC provided ~$16bn in financing, and a $2bn loan from Microsoft
• The last three tech deals by Silverlake included Skype (213% returns), disk drive maker Seagate Technology (730% returns), and chipmaker Avago Technologies (430% returns)?

Existing shareholders

• Southeastern AM was the largest outside shareholder for Dell, holding a 7.5% stake
• According to their analysis, the stock should have been valued at over $20-per-share. Given the offer was at $13.65-per-share, why did they support the deal? Southeastern AM knew that given the size of the deal and required equity, it was difficult to see the deal being done without the support and equity of Michael Dell
• 25 largest holders after Michael Dell owned 42% of the stock; ~60% of them had a cost basis of $15-per-share or less, or were passive, also supported the deal

Special Committee:

• The board of Dell formed a special committee to consider the deal and other options.
• Options included separating the PC and enterprise businesses, doing a "spin merger" with the PC unit and a strategic partner, tackling more "transformative" acquisitions, changing out management, doing a leveraged recapitalization, increasing buybacks and dividends, and selling out to a strategic buyer.

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Go-shop Period:

• The Special Committee of Independent Directors opened the floor in compliance with the go-shop provisions.
• The initial go-shop period was 45 days.
• Evercore Partners acted as the financial advisors to the Special Committee of the Board.

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Go-Shop Offer #1: Mr. Carl Icahn

• This part of the story also features an old friend and well-known raider – Mr. Carl Icahn. (Carl Icahn prominently features in one of my previous articles here).
• Mr. Icahn emerged as an early opponent of Dell’s $25bn bid during the go-shop period of 45 days. A month after the offer was made public, Icahn unveiled a sizable stake in Dell to try and block the deal. He criticized the bid as too low and attacked Michael Dell for attempting to swipe the business from other shareholders on the cheap. “We see no reason that the future value of Dell should not accrue to all the existing Dell shareholders — not just Michael Dell,” Icahn wrote in a letter to the Dell board committee. Icahn was ultimately successful in squeezing out another $500m for shareholders (adding to the original offer of $24.4bn). Raiders once again prove their very relevant role in the M&A world.
• To further reimpose his case, Icahn and Southeastern AM (largest outside shareholder for Dell) together decided to recruit a big-name tech executive (rumoured to be former Compaq CEO Michael Capellas according to Forbes) as a potential replacement for Dell and flew him out to Icahn's house in New York. They even agreed to pay him a fee of $10m to join the team, whether the deal went through or not.
• And was Icahn wrong? Well… After mixing in Dell’s 16% ownership, valued at more than $3bn at that time, and another $750mn in cash, with $19.4bn from Silver Lake and a consortium of lenders, Dell now controls a 75% stake. The only investor conversation he has to have, he says, is with "self."

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Go-Shop Offer #2: Blackstone

• Blackstone also peaked into Dell during the go-shop but withdrew, also citing the PC market slump as the reason.

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Termination fees:

• A successful competing bid during the initial go-shop period would bear a $180m (>1%) termination fee and for a competing bid post the initial go-shop period, the termination fee would be $450m
• This means in the event that the public company would have been able to find another suitor – they would have paid this termination fee to the consortium of Michael Dell, Silver Lake, and Microsoft.

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All cash deal:

• Dell stockholders received $13.65 in cash for each share of Dell common stock they held, in a transaction valued at ~$25bn, a premium of 25% over Dell’s unaffected closing share price of $10.88 on Jan. 11, 2013, the last trading day before rumours of a possible going-private transaction were first published. This valuation saw a jump of ~35% on Dell’s EV.

To put $13.65-per-share into perspective –

• Share Price History – Dell was bought at $13.65-per-share in Feb-13
• 52-week low (16-Nov-12) – $8.86 (paid 54% premium on this)
• 52-week high (16-Feb-12) – $18.32
• Before deal rumour (11-Jan-13) – $10.88 (paid 25% premium on this)

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Expected advantages of taking Dell private:

• The world's third-largest PC maker had no plans to abandon the PC, despite sinking fortunes. In fact, Dell planned to sell way more of them, even at a loss! Selling boxes on the cheap allows Dell in the door to upsell customers on lucrative software and services. Dell has driven down the prices of PCs many times before. But a PC maker selling PCs at a loss? That's the kind of thing you get to do when you take a company private. They could sacrifice profitability without being answerable on their PC business to get into new customers, for upselling software and services.
• Expected weakness in the PC market, market share losses in key emerging markets that had been big profit drivers, and spotty growth in the enterprise unit were some other drivers. Dell saw soaring demand for tablets, which it sold only in limited supplies, and smartphones, which Dell didn't manufacture at all.
• Dell had extremely exciting software assets that were not valued by Wall Street at the time because they were surrounded by the legacy PC business. The new investors had the opportunity to flexibly restructure the existing business model and make it more sustainable.
• Though Dell had a ~$20bn debt to service, the cost to service its debt was less than what Dell spent on dividends and stock buybacks over the last five years. It had added flexibility to pull off the rebalancing act without the public markets to worry about.

Post 2011, things started to change for the PC market. The PC global sales had reached their peak in 2011, and 2012 was the first of an 8-year streak of decline that lasted until the pandemic hit. Dell had lost its position as a top PC seller in the US to HP; and tumbled down to the third spot in the global PC market, behind HP and ACER.

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Well, Dell is a classic case of one of the biggest privatisations to date. In 2012, many believed that Dell was a dying company that would perish like Kodak or Motorola. But Dell went on to change business strategies and transform their business model, to survive and thrive in those market conditions.

This was the first part of the Dell case study and in the second part, we will further deep dive into Dell’s revival and strategic transformation. Until then, thank you for your time. Please post your feedback and comments.

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Please find below all the information sources that have been instrumental to the above article, along with some additional reading materials. Gratitude to all the creators –

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1.????? https://www.forbes.com/sites/antoinegara/2021/08/03/deal-of-the-century-how-michael-dell-turned-his-declining-pc-business-into-40-billion-windfall/?sh=57ef7bcd5c2a

2.????? Mergermarkets

3.????? https://www.forbes.com/sites/ilkerkoksal/2020/01/02/vmware-closes-27-billion-acquisition-of-pivotal-software/?sh=60c83498e6ae

4.????? https://www.forbes.com/sites/jeanbaptiste/2012/12/12/dell-quits-smartphone-business-globally-android/?sh=7bc136db4cce

5.????? https://www.livemint.com/Companies/9JEJmUE6ZeFN5o22KFt5GN/Timeline-Dell-since-1984-a-rollercoaster-ride.html

6.????? https://www.businesswire.com/news/home/20130205006211/en/Dell-Enters-into-Agreement-to-Be-Acquired-by-Michael-Dell-and-Silver-Lake

7.????? https://archive.nytimes.com/dealbook.nytimes.com/2013/02/08/how-dell-tried-to-avoid-potential-buyout-pitfalls/

8.????? https://www.nytimes.com/2018/10/15/business/dealbook/carl-icahn-dell.html

9.????? https://www.forbes.com/sites/connieguglielmo/2013/10/30/you-wont-have-michael-dell-to-kick-around-anymore/?sh=7d7d0d582a9b

10.?? https://www.chegg.com/homework-help/questions-and-answers/founder-dell-computer-michael-dell-featured-forbes-magazine-november-2013-states-carl-icah-q61923001

11.?? https://www.chegg.com/homework-help/questions-and-answers/founder-dell-computer-michael-dell-featured-forbes-magazine-november-2013-states-carl-icah-q61923001

12.?? https://www.forbes.com/sites/ericsavitz/2013/02/05/dell-will-southeastern-asset-back-the-buyout-deal/?sh=102eb50e139d

13.?? https://www.dell.com/learn/pa/en/pacorp1/new-dell

14.?? https://www.barrons.com/articles/dell-stock-take-private-51654806221

15.?? https://www.computerworld.com/article/2806792/dataquest--consumer-shipments-boosted-2002-pc-sales.html

16.?? https://www.tech-insider.org/statistics/research/2002/0117.html

17.?? https://www.mbaknol.com/management-case-studies/case-studybusiness-model-innovation-and-customer-driven-innovation-at-dell/

18.?? https://www.nytimes.com/2007/02/01/technology/01dell.html

19.?? https://i.dell.com/sites/doccontent/corporate/secure/en/Documents/dell-closing-costs.pdf

20.?? https://www.wallstreetprep.com/knowledge/premiums-in-ma/

21.?? https://www.cascade.app/studies/how-dell-strategy-transformed-it-to-industry-leader

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