Dell Backs off From Quest... for Now

Just like the stock market these past few bad days, Dell (Nasdaq: DELL  ) appears to be sounding the bugle for retreat. According to after-trading-hours media reports, talks between it and Quest Software (Nasdaq: QSFT  ) regarding the acquisition of the latter have broken down. Barring some unforeseen circumstance, however, it's probable that this is far from the last we'll hear about this takeover story.

Wanted: a thriving business line
Like a dehydrated man crawling through the desert in search of water, Dell is famously in need of new sources of revenue. After all these years it's still very much a hardware company selling products that moved into the low-margin commodity realm long ago. The firm hasn't managed to parlay its skill in assembling and selling PC systems into hotter and more viable product segments. Consequently, in the past five years its top-line growth has been largely stagnant.

The story has been similar in terms of net profit, which has trended sideways with the exception of a decent 2011; of late, however, quarterly figures have slipped. The company's most recent quarter saw its profitability slump on the back of weakening demand; as a result, the company dialed down its outlook for the rest of the year. Its share price promptly fell by nearly 20% after this confession.

Hence its search for higher-margin product lines. At this point, it doesn't seem to be all that choosy. Earlier this year, for example, it opened its wallet to buy AppAssure, a company specializing in data backup solutions. A few months after that was the buyout of security solutions firm SonicWALL, only to be followed by the company pocketing Wyse, a cloud-computing provider that also trades in so-called "thin client" products.

Hardware is undeniably a dead end for the company. It's got tablet products but the market seems to consider these to be a case of too little, too late. Which is quite a shame, because that's where the growth is in hardware these days -- just look at the phenomenal success story of Apple (Nasdaq: AAPL  ) , for which sales of iPads more than doubled year over year in its most recent quarter. Contrast that with Dell's slide of 0.8% in revenue from sales of its still-flagship PC line in the same time frame.

Time to spend some more bucks
With nearly $14 billion in cash and less than half that amount in long-term debt, Dell's got money to spend. As indicated by the continued share-price slump, it also seems to have plenty of shareholders with crossed arms and furrowed brows expecting it to buy its way out of the financial doldrums. Quest's market cap is around $2 billion, so any bump in the asking price will still easily be within what Dell can afford.

At this point, Dell seems very much to prefer going the acquisition route rather than clomping down the path of a company like Hewlett-Packard (NYSE: HPQ  ) . That formerly big-spending firm is facing a similar problem with stagnant hardware sales, but is trying to reverse this through job cuts rather than acquisitions. HP will let go of around 27,000 people (out of its current total of approximately 325,000), which hasn't affected any acquisitions so far this year and doesn't appear likely to. In fact, the majority of the cuts will be made at the unit that includes one of its monster buys, the once-independent company Electronic Data Systems.

Bidding war?
Another factor supporting an eventual buy of Quest by Dell is that the former company has at least one other rich suitor. It's in play because it agreed this past March to be taken private by financiers Insight Venture Partners at $23 per share. That led to what Quest said were several subsequent offers during the "go-shop" period (i.e., time when a publicly traded company may entertain other bids even after a firm buyout offer). One of these bids was Dell's.

Considering Dell's fat bank account, that bid seemed like a lowball pitch. It apparently offered a range of $23-$26 per share, valuing Quest at $2.19 billion in total at that higher figure. Meanwhile, an analysis by JPMorgan puts the proper value of the company at $28 per share, or around $2.36 billion. That $170 million difference is a big chunk of change to you or me, but it's walking-around money to Dell with its almost $14 billion.

The share prices of both companies followed the broader market by slumping the day the reports of the talks came out. Quest closed Friday at $23.74, down from its close of $25 the day before. This is a company with a determined suitor or two, however, so don't be surprised if that price rises before long, and if it's ultimately buyout-hungry Dell that's responsible for that lift.

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Fool contributor Eric Volkman owns no stocks mentioned in the story above. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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