InsightaaS 'Vitamin Y' posts provide concise analysis of industry events and developments. This post examines Dell's record-setting $67 billion acquisition of EMC.
Context: Since becoming a private company, Dell has touted its ability to make decisions that extend beyond investor focus on 90 day results cycles. The firm has also been shoring up some of its more strategic product lines – notably, security – to reorient away from its historical position as a provider of low-cost PC and server hardware to a role as a more sophisticated supplier to businesses that view technology as a strategic asset rather than as a tactical necessity.
On October 12, Dell took an enormous step along this path, announcing a "definitive agreement" to acquire EMC (including EMC's ownership positions in VMware, RSA Security, Pivotal Software, Virtustream and other industry firms and joint ventures) for $67 billion – the largest-ever acquisition in the information technology industry. The acquisition greatly enhances Dell's position in higher-margin, higher growth markets: storage is expanding faster than servers or PCs, and EMC is focused on the higher-margin software used for device management, as opposed to the creation of physical devices themselves. The deal was announced to analysts and media in a conference call that featured Dell founder and CEO Michael Dell, EMC president/CEO/chairman Joe Tucci and Silver Lake Partners managing partner and managing director Egon Durban, and included VMware CEO Pat Gelsinger, Dell CFO Thomas Sweet, and David Goulden, who acts as CEO for EMC's Information Infrastructure business.
In introductory remarks, the three principals stressed the expanded opportunity available to a combined Dell/EMC entity. Michael Dell led off by stating that "the combination of Dell and EMC will create the industry leader in the extremely attractive, high-growth areas of the $2 trillion information technology market, with complementary products and solution portfolios, sales teams and R&D investment strategies." Tucci highlighted the "tremendous transformation" in which "the older style of IT is being disrupted," but which is "incredibly rich with opportunities" arising from telemetry and sensors that result in modern applications with "a thousand times as much data, about a thousand times more users," adding that capitalizing on this scale of use requires the increase in portfolio and reach that the merged companies can deliver. For his part, Durban emphasized that "it's very rare that you have a first mover advantage around an industry consolidation," adding that the new company, "with the capital base that it has, is going to be able to innovate and distribute...a superior portfolio to enterprise customers who need it, across the world and of every size."
Durban's central role in the call, and the positioning of the deal as an acquisition of EMC by "Dell and Silver Lake Partners," is interesting. While Dell (the person and the company) will clearly drive the operations of the newly-expanded firm, it is equally apparent that Silver Lake is positioning itself as a central force within the technology industry. This is an unusual position for a private equity firm, and may signal that excellence in financing is joining excellence in inventing technology and excellence in technology marketing as paths to the industry's pinnacle.
Focus on growth rather than savings. Given the margin pressure that hardware suppliers are under, it would be reasonable to expect that the merger would include emphasis on identifying and addressing staffing redundancies between the two organizations. None of the participants on the conference call wanted to talk to this issue, though. Michael Dell acknowledged that there are savings to be had, but added that Dell has been investing in its workforce, highlighting the addition of 2,000 sales staff in the last six months.
Instead, the conference call's message focused on "revenue synergies." The conference call participants didn't offer a lot of specifics on this point, but Michael Dell stated twice that the analysis of the deal had found "revenue synergies that are three times larger than cost synergies," implying that the justification for the deal comes primarily from new growth opportunities, rather than from squeezing out costs through headcount reductions.
It can be assumed that most of this growth potential comes from enhanced market rather than product positioning. In his remarks, Michael Dell noted that Dell/EMC (including VMware) have already established "leadership positions in storage, servers, virtualization and PCs," and have strength in IT's "most important growth vectors," including software-defined data centres, hybrid cloud, converged infrastructure, mobility and security – and are "positioned as a leader in an amazing 22 Gartner Magic Quadrants."
If Dell and EMC are already leaders in all of these large and/or expanding areas, though, where will further growth come from? It appears that Dell and Silver Lake are banking on the benefits associated with increased customer account presence. In particular, Michael Dell noted that "as the data market moves to a compute-centric, converged model, Dell's server franchise is a natural fit with EMC's strength." The theory appears to be that by combining EMC's prowess at selling to enterprise accounts and Dell's broader compute portfolio, the company can increase share of wallet within major accounts; there is also some opportunity for using EMC to drive increased storage presence within Dell's "growing commercial infrastructure franchise" in the SMB base, but this is likely to be a secondary consideration.
Impressive security portfolio. Dell has been investing heavily in building a comprehensive security portfolio, assembling managed services and advanced threat identification services firm SecureWorks (acquired by Dell in 2011), firewall/unified threat management from vendor SonicWALL (acquired in 2012), backup software specialist AppAssure (2012) and identity monitoring and management software vendor Quest (also acquired in 2012), plus related capabilities sourced from thin client vendor Wyse (purchased by Dell in 2012) and from work done by Dell's own engineering team. With the acquisition, the company adds encryption pioneer RSA Security (which became a division of EMC after being acquired in 2006) and enterprise mobility management supplier AirWatch (acquired by VMware in 2014), and the portfolio becomes even more diverse. Dell has been positioning end-to-end security as a differentiating feature of its infrastructure portfolio for some time now. With the acquisition, Dell's security story becomes even stronger, and even more distinct from the approaches of competitors like Lenovo, HP and Oracle.
Viewing hybrid and SDDC as offering "first mover" advantage. Although it's tempting to look at a Dell/EMC/VMware amalgamation as a means of consolidating a converged infrastructure offering capable of competing with the Cisco-led Vblock (Cisco, EMC, VMware) and FlexPod (Cisco, NetApp, VMware) offerings, it appears that Dell's vision is broader and more strategic. Michael Dell believes that "the combined company is very well positioned to address the move to the cloud," both by providing infrastructure to public cloud providers and private cloud operators and through VMware's ability to enable hybrid cloud. But in his remarks, he went further, observing that "I think what you're seeing with the Software Defined Data Center is an ability to take the benefits of the public cloud and bring them into an on-premise data center." Mr. Dell considers the complexities associated with connecting compute, network and storage as a major demand driver for public cloud, and virtualization and converged infrastructure as a means of delivering greater simplicity in on-premise environments, allowing firms to focus on optimizing for "the application user, quality of service and security."
But Dell isn't simply focused on leveling the terrain between cloud and on-premise infrastructure. Looking into the future, he talks to the increase in devices (from one billion to 100 billion plus), and a corresponding increase in the number of applications and the amount of data processed – and sees that "there will be public clouds. There will be Software-as-a-Service...there will be hyperclouds, there will be private clouds." Dell's vision is to supply the infrastructure across these different environments, providing common, connected and secure platforms to customers of all sizes, wherever their IT workloads reside.
The bottom line: While there are reasons to admire Dell's strategy, it should be noted that when it comes to IT mergers, "1+1" is much more likely to yield something like "1.6" than two, and despite confident talk of synergies, a merger yielding a combined market presence that eclipses the individual positions of the firms involved is even rarer. Often, this has more to do with operations (and even personalities) than strategy. These are still early days, and the hard decisions won't need to be made until mid-2016, but there are still many operational issues to be ironed out between now and then.
At a personality level – at least at the most senior level – this merger seems relatively easy to conclude. Tucci is 68, and has been talking about retirement for several years. He won't be tempted to stay and divide loyalties within the expanded Dell, and in fact, will receive just over $27 million for his service in the period leading up to the close of the deal. There will no doubt be other management personality issues to address, but the inclusion of Gelsinger and Goulden on the call indicates that Dell recognizes and is taking steps to address potential friction.
At a financial level, the issues are more complex. Even though Dell isn't a public company, it will need to explain its expectations of "revenue synergies" to customers, analysts and the press, and Silver Lake will likely need to do the same for its current and potential investors.
The cost of debt will have an impact on the overall cost of operating the newly-expanded Dell entity. Dell was thought to have about $12 billion in debt prior to this deal; clearly, this figure will increase substantially after the acquisition. Michael Dell did state that observers could expect "a significant deleveraging" resulting from cost savings, increased revenue and cash flow management improvements that come with being a private company, but $67 billion represents a very high hurdle for these activities. Obtaining the funds themselves isn't an issue – CFO Sweet stated that "the banks are fully committed" to funding the transaction – but it seems likely that the costs associated with debt service will affect product prices and margins, and it is difficult to boost either in many of Dell's core hardware markets. It might well be that asset sales become important to enhancing corporate profitability by reducing the cost base of the company.
Should debt reduction become a priority, the newly-expanded Dell would have a few options, starting with VMware. Although there was no mention of selling VMware as part of this deal – indeed, VMware CEO Pat Gelsinger was described as having a "very bright future" in the new organization – EMC's 80 percent stake in VMware is worth more than $26 billion at current valuations. It will be very tempting to convert this equity into reduced debt to help the competitiveness of future hardware products, though this would be at the cost of an ownership position that (as per the terms of the Dell deal) accounts for 40 percent of EMC's overall value. There are other avenues Dell could pursue – for example, it could combine its in-house security assets with RSA, and perhaps AirWatch, to create a stand-alone security business that could be monetized via issuance of public market shares – but a VMware sale is clearly the most direct means of raising capital to reduce debt.
An often-overlooked ingredient in a merger is the extent to which go-to-market staff and strategies can (or should) be melded in a single organization. This will likely be a significant issue for the expanded company. Dell and EMC market-facing staff have very different skills and compensation levels, and can't be neatly amalgamated into a single sales force. The channel strategies of the two firms are different as well. Because EMC has focused primarily on large deals within large accounts, and Dell has been more SMB (and consumer) focused, it may be that the sales staff and channel strategies can be aligned by sector, but that won't erase the GTM discrepancies. EMC sales staff work large, high margin deals, and are among the best compensated reps in the industry; Dell certainly can't afford to reduce EMC-classic rep compensation (which would trigger a mass exodus to competitive startups) or to pay EMC rates to Dell-classic sales staff (which would consume more than 100 percent of current margins). From a channel and alliance perspective, EMC is a strategic partner to its enterprise-level services and software partners; Dell is primarily a tactical resource for SMB-focused VARs and integrators. These approaches target different partners with different programs and are delivered in different ways. Again, it's possible to align strategies by market sector, but many partners are likely to try to 'shop' across programs to 'Frankenstein' together blends of services and compensation structures that optimize the supplier benefits that they derive from the new Dell, and some – notably, Cisco, which is an EMC ally via Vbock – will find a Dell partnership untenable.
The 'net net'
While Michael Dell may believe that "this combination makes great sense because of the obvious ways our businesses complement each other, and [will] enable us to grow," there are reasons to both admire and to question the Dell/EMC deal. In the main, the answer to the $67 billion question will be found in the opportunities for "revenue synergies" that extend well beyond today's converged infrastructure SKUs, and into the cloud and the core operating models of customers ranging from EMC's traditional public sector and large enterprise accounts to Dell's SMB buyers. If Dell can extend its reach across the full spectrum of IT/business infrastructure, it may build a position as the behemoth HP believed it would become, before it was bifurcated into two distinct business units. If it does not, it may more closely resemble Oracle, trying to assemble a coherent vision from a series of mismatched pieces. In the case of Dell, the answer to "1+1=...?" is an open, but intriguing question for customers, partners, and the industry as a whole.