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Why Oracle Should Buy Dell This Year

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Dear Larry Ellison, CEO of Oracle (Nasdaq: ORCL  ) :

Mr. Ellison, my hat is off to you: You are the founder of a company that is worth nearly $160 billion, get to sail in the America's Cup in your 60s, are married to a romance novelist (with Steve Jobs as your wedding photographer, no less), and are the third richest man in America.

But for all your personal and professional success, you have a growing problem. That problem is called Hewlett-Packard (NYSE: HPQ  ) . HP shipped 17.5 times more servers last year than Sun (which you recently acquired), and is No. 1 to your No. 5.

And since when have you settled for being No. 5?

But I know how to solve your problem in a way that will also make your shareholders wealthy. And I'm going to tell you for free, because I'm that kind of chap.

You should acquire Dell (Nasdaq: DELL  ) , even if it means paying double the current share price (or $27.10 per share) in a hostile takeover.

Flying too close to the Sun
Mr. Ellison, critics are starting to doubt the Sun acquisition because of plummeting market share in servers (now at 6.7%). The company that fired Mark Hurd, unfortunately, also managed to oust IBM (NYSE: IBM  ) as this year's sales leader. And the trend shows no sign of abating. In the third quarter, HP and IBM grew server revenues by 22.2% and 9% year over year, respectively, versus Sun's own anemic 0.9% growth.

But Dell is ripe for conquest: For a measly $25 billion-$52 billion (depending on the takeover premium) you can add an additional 14+% of market share in the server market. And a growing one to boot -- in the third quarter, Dell's server business grew revenues by 18.7%, twice as fast as No. 2 IBM and nearly identical to HP.

And of course with Dell you're not just getting servers: You're getting the PC market. And who better to help you understand this market than your newest hire, former HP CEO Mark Hurd? Do you have any doubt that Mark Hurd, who spruced-up HP, couldn't work some magic with Dell? And with a Dell acquisition, Oracle would triple its annual sales by simple math.

What you get when you buy Dell
But even if Hurd and you don't change anything about it, you're still getting a great deal when you buy Dell.

I should know; I'm a Dell shareholder.

Dell generated a whopping $3.5 billion in free cash flow in fiscal 2010. That's for a stock that costs $26 billion to buy.

So my little piece of the company is generating a nice 13.46% internal rate of return on its cash flow. And that's assuming no growth from fiscal 2010's results.

But wait, there's more. Dell has a $13.3 billion cash hoard. That's half the cost of the company! So let's assume for a second you were to buy the company, pay off all of Dell's debt, and then pocket any remaining cash. In that case, the business costs you not $26 billion, but $19 billion.

So now you have a business that generates $3.6 billion (after interest expense savings) but costs only $19.2 billion to acquire. That's an 18.75% IRR ... and again assuming no growth or cost savings from the merger.

You're gonna pay
Let's be honest, Mr. Ellison. I have something you want. As a Dell shareholder, I'm not going to let that 18.75% go without a fight ... or a sizable takeover premium. And since Michael Dell, who owns 12% of the company, is likely to vote down any takeover, the premium offered to shareholders better be big ... possibly even 100%.

A 100% takeover premium, or $27.10 per share, would take your annual return from 18.75% down to 8.15%. Assuming you and Hurd can grow Dell at a conservative 3%, that's still an 11.31% return even with an onerous takeover premium.

And with your strong balance sheet, the cost of financing the transaction will be far less than the 11.31% received, so Oracle shareholders go home happy.

And here's the kicker: The value mavens at Southeastern Asset Management are the single largest shareholder of Dell (at 7%) after Michael Dell. If you recall, Mr. Ellison, they were the single largest shareholder of Sun Microsystems when you bought Sun, too, and they were supportive of that deal.

So perhaps you should give them a call ... for old time's sake.


Chris Baines

Fool contributor Chris Baines enjoys playing matchmaker on occasion. He actively participates in CAPS as cbaines2. Chris owns shares of Dell. He is also an investor in Longleaf Partners, a mutual fund that is managed by Southeastern Asset Management. The Fool owns shares of International Business Machines and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (25)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 04, 2011, at 9:19 PM, mattsmithsd wrote:

    Excellent post! I think you did a great job backing up your reasoning as well, most people don't do that good of a job...You should send this to Larry Ellison's email.

  • Report this Comment On January 05, 2011, at 5:10 AM, ceoworld wrote:

    I agree :)

  • Report this Comment On January 05, 2011, at 10:27 AM, 66661111 wrote:

    Oracle has no intentions on buying Dell and nor should they. Oracle has made it clear; they are in the HW business where the margins are. This means that they are in the high end, mission critical OLTP and DW HW business. Dell does not usually play in those environments. Dell is more of a commodity player. Also, Oracle has nothing to do with the PC business. They will stay away from it even if their life would depend on it. Oracle plays in the data centers and will stay there for a while.

    You should rather look for Oracle to invest in computer chip makers and storage servers providers for their next HW acquisitions. A big strategic acquisition would be EMC. It would be a nice complement to Oracle's suite of products. It would also potentially mean a stake in fast growing and pervasive VMware. On the s/w side: Informatica, Tibco and maybe a Citrix could all be strategic acquisition targets. Storage, inegration and virtialization is at the hearth of Data Centers and that's what is fueling Cloud Computing.That's where Oracle is a big player and that's where they will grow in the short to mid term.

    I do not see Dell as remote possibility.

  • Report this Comment On January 05, 2011, at 10:30 AM, Techlog wrote:

    Is this the only way Dell shareholders will make money? What is good for Dell shareholders may not be so good for Oracle shareholders. Dell is still mostly a hardware company. The game is in the Saas and Cloud, and Ellison is better spending the money on application corp. This is what he did in the past and succeed. His strategy is very simple: buy everything that can disrupt the application-data market.

    Dell is always late in the game. They get in service 5 years late. They are trying to beef up their storage offer, but again, too late. Reselling EMC was a bad move, and now they are trying to catch up, but there is nothing left except Compellant and Nettap. HP generous offer for 3PAR was very strategic. Can Dell bough Nettap? Too expensive.....

  • Report this Comment On January 17, 2011, at 11:00 PM, ummmmmmno wrote:

    I wonder how many dell servers run solaris? In fact last time I checked this wasn't even an option when configuring their servers. Redhat an option yes, vmware is an option but not solaris.

    This might have flew with open solaris mind you.... Or maybe dell branded free solaris, but Dell's meat and potatoes is not Solaris. It would isolate its core vendor microsoft....

    Similarly spark sales are made at a huge premium because of the perceived tight os hardware integration. Do they want to say dell and spark are just as good.... or that solaris and microsoft are substitutes? In my mind it creates a branding nightmare. And after all the bad sun ms blood it would be a bad synergy.

    Similarly I'm not sure that Oracle should focus on a virtualization platform. Virtual box isn't a contender. KVM is spoken for, and the market is so saturated that it's a losing fight. Zen is free, and microsoft and vmware are going to war. It's way to late to jump into the virtualization shark tank in my opinion. Buying a mid-teer storage platform is probably a better bet.

    Finally my feeling is that after all these technology snap ups the cultures of these companies are train wrecks. Golden handcuffs last so long, there are going to be serious problems issues here.

    How do you think the eva group, the 3par group, and the lefthand group are all getting along at hp? Vying for budgets, with totally different fundamental approaches to storage.

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