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Connie Guglielmo,
Forbes Staff
I cover the people
and technology driving Silicon Valley |
Forbes
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10/29/2013 @ 11:30AM
Dell Officially Goes Private: Inside The
Nastiest Tech Buyout Ever
This story appears in
the November 18, 2013 issue of Forbes.
Eight months is a
long time to stay mum, especially for a tech industry wunderkind, as
Michael Dell was, and one of the world’s richest men, as Michael Dell
is, while enduring daily bombs from Carl Icahn about his leadership
and ethics. (“All would be swell at Dell if Michael and the board bid
farewell,” Icahn tweeted at one point.)
So as he strides in
front of 350 employees in the glass-enclosed conference room of Dell’s
Silicon Valley division a few weeks ago, with celebratory gourmet
cupcakes frosted with the company’s blue logo nearby, you can
literally feel a weight coming off his chest. “It’s great to be here
and to not have to introduce Carl Icahn to you,” says Dell, the parry
prompting laughter and cheers. “We’re the largest company in terms of
revenue to go from public to private. In another week or two we’ll be
the world’s largest startup.”
It’s not that Dell
hasn’t been talking. Ever since February, when he announced his plan
to take his eponymous company private, armed with his own fortune and
billions from the private equity firm Silver Lake Partners, he’s
traveled the globe–including three trips to China–privately reassuring
everyone who would listen that Dell was business as usual. But at the
advice of counsel he kept a tight lid on talking about the buyout.
Now,
having closed a $25
billion deal to take the company he founded in his dorm room private,
the shackles are off. He can say what he wants–and do what he wants,
too. After mixing in his 16% ownership, valued at more than $3
billion, and another $750 million in cash, with $19.4 billion from
Silver Lake and a consortium of lenders, he now controls a 75% stake
in the Round Rock, Tex. company. The only investor conversation he has
to have, he says, is with “self.”
So what is Dell now
saying to himself, as well as customers, partners and employees?
Most critically, the
world’s third-largest personal computer maker has no plans to abandon
the PC, despite that product line’s sinking fortunes. In fact, he
plans to sell way more of them and, if the recent past is any guide,
he may just sell them at a loss. Selling commodity boxes on the cheap
allows him to get 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 as a loss leader? That’s the
kind of thing you get to do when you take a company private. “We’ve
always viewed [PCs] as a business that’s got a life cycle to it.
Growth is in new areas, and it’s a business you’ve got to manage very
efficiently from a cost structure. It’s still a great way to get into
new customers,” says Dell.
The world got a
taste of this land grab in Dell’s last quarter as a public company.
Net income dropped 72% from a year earlier–but Dell’s PC share ticked
up one percentage point, its largest move in almost three years.
There’s a long way to go to rebalance the business. After four years
of work and $13 billion in services, software and other acquisitions,
the firm still gets more than 60% of revenue from PCs. Dell’s market
share in services and software stands at less than 1%, but these are
the only categories making money and growing. Enterprise solutions,
software and services revenue was up 9% in the latest quarter, and
services comprised 100% of total operating profit. And in addition to
battling traditional rivals like Hewlett-Packard and IBM, the company
also has to worry about IT newcomers such as Amazon and Rackspace,
which are wooing businesses with cloud-based services.
Yet some of the
smartest minds on Wall Street, including Icahn, are convinced Michael
Dell and Silver Lake got a steal at $25 billion, putting 20% down. “I
agreed with the shareholders that he was not paying a fair price for
Dell and that they were getting hosed,” Icahn says.
Hosed may be too a
strong a word. No one else but Dell wanted the company that badly, not
even Icahn, who had a “win win,” walking away from eight months of
grandstanding with a stake worth $2.2 billion, and after squeezing out
another $500 million for shareholders. The growth-challenged company
will be buried under just less than $20 billion in debt in an industry
in secular decline.
But Icahn knows what
Dell does: that without dividends and buybacks, he should have enough
cash flow to cover the interest payments. And without the public
markets to worry about he has the flexibility to pull off the
rebalancing act. Silver Lake, which in its last three tech deals
reportedly made 213% on Skype, 730% on disk drive maker Seagate
Technology and 430% on chipmaker Avago Technologies, can do the math,
as well. Conservative estimates peg the potential returns on this
leveraged buyout at 11% a year, based on the most recent dismal
earnings. And if cash flow growth comes back–or the current results
are being, shall we say, sandbagged a bit? Then Dell will neatly
bookend the founding legend of his University of Texas dorm room.
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Michael Dell addresses employees in Silicon Valley after winning
his bid to take his namesake company private. (Photo credit:
Christopher Peacock) |
“Michael has
extremely exciting software assets that haven’t been valued by Wall
Street because they’re surrounded by the legacy PC business,” says
Salesforce.com CEO Marc Benioff. “For Michael to realize the value of
these new assets–he has this incredible security asset as well–Michael
needs to take Dell private and restructure the company.”
Before diving into
the challenges ahead, though, there’s a question a lot of people have
pondered that needs asking: Why him? Dell had more than five years to
lead a turnaround and failed. Shareholders have been treated to a
negative 43% total return since he reclaimed the CEO job. Why not just
walk away with his $16 billion in net worth ($12 billion of which is
outside of Dell) and establish a new legacy?
“I will care about
the company after I’m dead,” says Dell. “I love this stuff. It’s fun
for me. I couldn’t be more thrilled to have control over my own
destiny in a way that is not possible as a public company.”
Brilliance and Bravado
Before Mark
Zuckerberg and Kevin Systrom, Drew Houston and David Karp, Michael
Dell defined the myth of the American tech prodigy. Only Bill Gates
and the Apple founders could come close. Dell was 23 years old at his
IPO in 1988, five years younger than Zuckerberg at the same milestone.
He was 29 when his company hit $1 billion in revenue and 31 when it
hit $5 billion.
The company’s first
president, Lee Walker, remembers the first time Dell came to see him
in 1986. “He eats most of my sandwich and all of my soup, and in
between slurps asks me if I can be president of his company. … He had
no money, no access to money.” Yet Walker eventually came on because
he could see that Dell possessed both brilliance and the bravado to
think he could take on HP and IBM as a college freshman simply because
he was willing to assemble PCs himself and sell them directly over the
phone.
By 2001, Dell
overtook Compaq for the worldwide PC lead and retook that lead two
years later from a now combined HP-Compaq. The company soon expanded
into servers, storage, printers, mobile phones and MP3 players. Things
were going well and Michael Dell was ready to let go. In 2004 he kept
only the chairman role, handpicking former Bain consultant Kevin
Rollins as CEO.
But underneath
things were starting to slip: customer service, product quality,
strategy, vision. By 2006 Dell had lost its No. 1 spot in the market,
having failed to see the massive industry shift from desktops to
notebook PCs. In 2007 Dell was back in the boss’ chair, ready to
rethink the PC business and where the information technology industry
was headed. Selling only PCs wasn’t going to cut it. Dell needed to
expand its software, networking, security and services offerings. “At
the scale of Dell, the only way you were going to move the needle
quicker was acquisitions,” he now says.
So Dell went on a
$13 billion buying spree, consuming more than 20 firms. The biggest:
the 2009 takeover of IT services provider Perot Systems for $3.9
billion, purchased at a 68% premium.
It wasn’t enough.
Dell was slow to the shifting IT tides. Other tech giants, including
HP, IBM, Cisco and Oracle, were already diversifying to grab market
share from one another’s businesses. In consumer, Dell was the
opposite of the Apple machine: no mobile, no retail, few premium
products that stood out. “We were all a bit frustrated with the pace
at which this transformation was moving,” says Brian Gladden, Dell’s
chief financial officer since 2008. “It’s a work in progress.”
Worse, investors
weren’t giving the company credit for progress made, with headlines
focused on shrinking PC sales and market share, rather than on the
fact that it had built the non-PC business from $10 billion to a
“pretty impressive” $21 billion in five years. “We’re working hard to
build this $21 billion business to $30 billion, $40 billion–and
basically you’ve got public investors saying, ‘You’re a PC company,
don’t invest in all this stuff. Don’t acquire all this stuff. Don’t go
invest in R&D,’” Dell says. By last June shares, which had traded
above $40 in 2005, had sunk below $12.
‘I Would Take Dell Private’
The chain reaction
of the past year started with a conversation in June 2012. Dell’s
second-biggest shareholder, Southeastern Asset Management, was
underwater and saw little upside. But it would be willing to roll a
chunk of its 146 million shares into a management-owned entity if the
takeout price was right. Dell says that he’d thought about going
private before but never broached it with the board. Still, his
interest was now piqued. In July Dell was at a tech conference in
Aspen and in the hallway ran into Silver Lake partner Egon Durban. “He
said, ‘Hey, I’d like to meet with you,’” says Dell. They agreed to
meet up in August in Hawaii, where both own luxury homes on the Kona
Coast.
They went for a
walk, and Durban, who had an investment team take a deep dive into
Dell before the meeting, floated the same idea. “I told Michael, ‘If I
were in your position, I would try to take Dell private. And I don’t
think you need Silver Lake to do it,’” Durban recalls. As to why the
deal made sense, he adds, “If Dell today were simply a PC company with
the ambition of transforming itself into a full-blown enterprise
solutions provider, that prospect would feel pretty scary. What in
fact has happened, however, is an incredible thing. Michael has
already transformed Dell into a thriving enterprise company.”
Dell also knows a
thing or two about private equity. His MSD Capital, with $12 billion
in assets, is bigger than Silver Lake’s most recent megafund. Dell
reached out to another Hawaii neighbor, George Roberts of investment
firm Kohlberg Kravis Roberts, to get his thoughts. Roberts agreed it
was possible and wanted to talk about doing it together.
“So then I said,
‘Time out. Gotta call the lawyer. Don’t want to make any mistakes.
Tell the board. Do everything the right way,’” says Dell.
Soon after, he
notified Alex Mandl, the board’s lead independent director, that he
was considering buying the company, little knowing then that it would
take more than a year (and more than a little anguish) to pull off.
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![](MichaelDellStandsAlone.jpg)
Michael Dell now
owns a 75 percent stake in the company. The only investor he has
to answer to, he jokes, is "self." (Photo credit: Christopher
Peacock) |
The board, according
to the detailed timeline of events recounted in Securities and
Exchange Commission filings, formed a special committee to consider
the idea and other options. These 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. Mandl gave Dell the go-ahead to call Silver Lake and KKR and
tell them the board was open to considering a go-private transaction.
Code words started flying: The PC maker was nicknamed “Osprey.”
Michael Dell went by “Mr. Denali.”
Lawyers and advisors
weighed in while the special committee sussed out the challenges to
Dell’s business. There were many. They included the “significant”
weakness in the PC market (PC shipments are expected to drop 8.4% this
year), share losses in key emerging markets that had been big profit
drivers and spotty growth in the enterprise unit. At the same time,
Dell saw soaring demand for tablets, which it sells only in limited
supplies, and smartphones, which Dell doesn’t manufacture at all. Dell
was also seeing lower returns on its acquisitions than management had
anticipated.
By October Silver
Lake (code name Salamander) and KKR had submitted bids hovering around
$12 per share. For his part, Michael Dell pledged he would participate
with “whatever sponsor was willing to pay the highest price.” The
November earnings report was dismal–the seventh quarter in a row of
results below management forecasts–and shares dipped below $9.
KKR, concerned about
PC demand, dropped out when the board’s Dec. 4 deadline rolled around,
leaving only Silver Lake. On Dec. 6 CFO Gladden provided updates on
the business and projections through fiscal 2016. He told the board
that “fully implementing” the plan to shift from PCs to enterprise
solutions would take another three to five years. It would also take
more money, a big concern since there were questions about whether the
cash flow from the dwindling PC business would be enough to finance
the enterprise expansion. The board asked private equity firm Texas
Pacific Group to bid, but it declined two days before Christmas.
By February, with
press reports already hinting at the buyout and the special committee
convinced there wouldn’t be other bidders, Dell and Silver Lake got
the go-ahead. In addition to Dell’s investment, Silver Lake put up
$1.4 billion, banks including Bank of America, Barclays, Credit Suisse
and RBC provided about $16 billion in financing, and Microsoft tossed
in a $2 billion loan to one of its biggest partners. Dell Inc. says
the cost to service its debt will be less than what it spent on
dividends and stock buybacks over the last five years.
The proposal also
included a provision for a 45-day “go-shop” process in which other
parties were invited to come courting. Enter Icahn. The veteran
opportunist says he got interested after some big Dell shareholders
(he won’t say who) called him for help. In a Mar. 5 letter to Dell’s
board he let them know he now owned $1 billion in shares and thought
the Dell-Silver Lake bid was too low. Blackstone also sniffed around
during the go-shop but withdrew in April, also citing the PC market
slump.
Icahn’s $10 Million Man
Throughout the
go-private saga, Dell never lost a big customer. That doesn’t mean
those customers weren’t nervous. A few asked for a change-of-control
provision in new contracts if Dell were no longer CEO. Others took “a
bit of a wait and see [stance], especially when it got a little bit
more turbulent,” says Marius Haas, who headed HP’s networking business
and joined Dell in 2012 to run Enterprise Solutions. When the going
got rough, the company sent in its CEO to reassure them that it was
business as usual. “Michael equals Dell, Dell equals Michael,” Haas
says. “He is the culture for employees, customers and partners.”
By June it was just
Dell and Icahn, who spent nearly $1 billion more to buy out
Southeastern’s shares. The billionaire investor used tweets, open
letters–headlining one “Let the Desperate Dell Debacle Die”–and media
interviews to barrage shareholders with his message that the buyout
undervalued the company, and that Michael Dell should be fired and the
board replaced. He pushed for a leveraged recapitalization, pressing
the company to borrow billions for a stock buyback to buy out
investors at a premium and issue warrants for the purchase of
additional shares in the future if the turnaround played out. To help
with his case, Icahn and Southeastern say they recruited a big-name
tech executive (whom FORBES believes to be former Compaq CEO Michael
Capellas) as a potential replacement for Dell and flew him out to
Icahn’s house in New York’s Hamptons. “He came for lunch and stayed
until midnight,” says Icahn. “We were so serious about getting him
that we agreed to pay him a fee of $10 million just to sign on to our
team, whether we won or lost.” The candidate soon after got cold feet.
“I’m not casting aspersions, but something happened to change his
mind.”
By the time
September rolled around, it was pretty clear that Icahn wasn’t a
serious threat to derail the deal. Most of the bidding up by Silver
Lake and Dell took place in the early going, and Dell says that Icahn
never submitted a formal offer after his June proposal.
“It’s a big poker
game to him,” says Dell. “It’s not about the customers. It’s not about
the people. It’s not about changing the world. He doesn’t give a crap
about any of that. He didn’t know whether we made nuclear power plants
or French fries. He didn’t care.”
He points to Icahn’s
stance that shareholders should have sought appraisal rights–a process
by which a judge determines the value of the shares. “He goes on
national television and says appraisal rights is a ‘no-brainer,’” Dell
says, shaking his head. “If you ask any lawyer who knows anything
about appraisal rights, they will say this is not a no-brainer. This
is very complicated. This is years of difficulty.” After shareholders
voted with Dell, Icahn said he decided against seeking appraisal
rights. “He just lies,” says Dell.
Donald Carty, the
longest-tenured member of the board besides Dell, says the
going-private transaction was handled “by the book” to make sure
shareholders’ interests were the priority. Business schools will study
it one day as “a classic case of doing it right,” he predicts.
Southeastern didn’t
make out so well, despite kicking off the whole affair. It began
buying Dell shares as early as 2005 and will likely take a $500
million loss from the transaction.
“This was not done
to get a bump up in the shares. We felt that company was worth over
$20 and the shareholders were not being served by the board,” says G.
Staley Cates, president of Southeastern. “The best alternative all
along was a leveraged recap, because you start with $15 billion of
cash on the balance sheet.”
The New Dell
Dell has no shortage
of people who think that the founder, in this case, can be the same
person who is the disruptor. “You have someone who knows the business
well and is not dewy-eyed with a romanticized view of the past,” says
Jeffrey Sonnenfeld, a professor at the Yale School of Management, who
has known Dell for two decades.
“I’m thinking of the
guts he has to do it,” adds Aneel Bhusri, co-CEO of software maker
Workday, which counts Michael Dell among its early investors. “He
could have walked off into the sunset and said ‘I can move on.’ I
think he’s making the harder choice.” Adds Silver Lake’s Durban: “We
would not want anyone else other than Michael to run Dell.”
The “new” Dell
starts with some promising metrics. The company that made its name
selling direct has more than 140,000 channel partners today, with
about $16 billion of Dell’s nearly $60 billion in annual revenue
coming that way, up from zero in 2008. It also doubled the number of
sales specialists with technical training to 7,000 in the past four
years. Two out of three business customers’ first experience with Dell
is buying a PC, and about 90% of those customers go on to buy other
products and services. The trick is getting the sales force to
cross-sell. How far along are they on that effort? “We’re in the
second to third inning,” says Jeff Clarke, head of the PC business.
It would help to
have new technology to sell. Dell has traditionally been stingy on
research and development, spending $1 billion a year, only 2% of
sales. In absolute dollars HP spends three times as much. Cisco spends
five times as much. But new gear is coming: One brisk seller is the
PowerEdge VRTX, introduced in June, that combined servers, storage,
networking and management technology into a single chassis designed
for small businesses.
The value in
technology is moving from the PC to the cloud. Dell just snagged a big
executive from Indian services giant Wipro to run its 10,000-employee
cloud infrastructure group. A typical customer of the new Dell looks
like Barclays, which uses Dell’s “private cloud” to run its mobile
banking services.
One of the bigger
unnoticed changes is the 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 and servers and storage), supported by one sales
organization. As a private company unshackled by Wall Street’s 90-day
attention span, Dell has boiled the priorities down to just two
metrics: cash flow and growth. “It’s incredibly clarifying,” he says.
There are two ways
to boost cash flow, of course, and one of them is to slash costs. Two
years ago Dell Inc. vowed to take out $2 billion over three years,
half of it from the PC business. As a private company it could do far
more. Dell may need to move away from the build-to-stock
model–customers call up and say what they want and Dell builds it,
without keeping costly inventory on hand–to a build-to-inventory
approach, where the company builds models and sells them off the
shelf. It’s a cheaper approach and has made Lenovo the world’s largest
PC maker, with increasing margins.
In some ways trying
to squeeze billions out through thriftiness brings Michael Dell back
to his roots, when the company was famous for charging employees for
their coffee (as it still does). The cupcakes that he was celebrating
with in Santa Clara are a tradition that dates to when Dell had its
first $1 million sales day. On that day everyone got a cupcake. But,
notes Dell, “just one.”
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