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Dell's Turnaround Plan Is One Big Gamble

By Adam Levine-Weinberg - Apr 2, 2013 at 8:00PM

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Last week, Dell filed a proxy statement that presented a fairly dismal outlook for the company's business. The recent bidding war to buy the company has driven Dell's stock price up, but the new information provided by the company shows that there is more downside than upside from here.

Troubled PC giant Dell (DELL.DL) has been embroiled in a months-long battle with shareholders over founder and CEO Michael Dell's plan to take the company private (with help from Silver Lake Partners and Microsoft (MSFT -0.37%)). Two of Dell's major shareholders, Southeastern Asset Management and T. Rowe Price, protested that the proposed buyout price of $13.65 was too low. Subsequently, Blackstone Group offered to pay $14.25 per share for Dell, and activist investor Carl Icahn offered to buy 58% of the company for $15 per share.

The recent bidding war has driven the Dell stock price well beyond the original proposed deal price of $13.65. However, last week Dell filed a discouraging proxy statement, which indicated that management expects things to get significantly worse for the company before any potential turnaround. The Special Committee of independent directors that evaluated the rival proposals concluded that the certainty of $13.65 cash from Michael Dell and Silver Lake was superior for shareholders to the Blackstone and Icahn bids, which would leave part of the company trading publicly. With Dell stock still trading at a premium to the Dell/Silver Lake offer -- $14.30 as of Monday's close -- it is high time for shareholders to sell and lock in gains.

PC weakness continues
Dell's big long-term problem is the decline of the PC, which has been cannibalized by the growth of mobile computing (i.e., tablets and even smartphones). The PC replacement cycle has slowed dramatically, pressuring Dell and competitors like Hewlett-Packard (HPQ -3.04%). Last year, HP had to write down the value of the Compaq trade name by $1.2 billion due in large part to declining PC sales. Yet the PC business is just a small part of what HP does, representing less than 30% of revenue and less than 10% of segment earnings from operations last quarter.

By contrast, while Dell has been trying to diversify into services, software, networking, and other growth areas, PC sales still represent half of the company's revenue, and roughly 25%-30% of earnings. As a result, Dell has a lot more to lose from the continuation of weak PC sales than HP. In last week's proxy filing, Dell stated that uptake of Microsoft's new Windows 8 has been poor, and enterprise upgrades to Windows 7 PCs have unexpectedly slowed as well. According to a study by Boston Consulting Group (commissioned by Dell), PC division revenue could decline by as much as $10 billion over the next four years.

What's the solution?
Michael Dell seems to be planning to double down on investments to move the company aggressively into the enterprise hardware, software, and services markets. The investments necessary to execute this transformation will depress profitability for several years. Given the strong competition in those markets from IBM, HP, and others, success is not assured.

It's hard to fault Michael Dell for taking drastic measures to revitalize the business he founded in his dorm room decades ago. The more moderate transformation strategy Dell has implemented in the past few years has failed to stop the company's fall. However, the proposed investments in research and development and sales force expansion will take years to pay off -- if they pay off at all. Dell, as a billionaire, can afford to gamble a significant amount of his wealth in hopes of revitalizing his company. Regular investors probably can't afford that kind of bet on Dell's long-term potential. With shares up 60% since mid-November, it's a good time for ordinary folks to lock in gains (or in the case of some long-term shareholders, cut losses).

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Stocks Mentioned

Dell Technologies Inc. Stock Quote
Dell Technologies Inc.
HP Inc. Stock Quote
HP Inc.
$35.73 (-3.04%) $-1.12
Microsoft Corporation Stock Quote
Microsoft Corporation
$253.14 (-0.37%) $0.94
International Business Machines Corporation Stock Quote
International Business Machines Corporation
$129.66 (-2.47%) $-3.28
T. Rowe Price Group, Inc. Stock Quote
T. Rowe Price Group, Inc.
$120.13 (-0.97%) $-1.18

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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