Dell/Perot Systems: Dell is paying through its nose in its search for direction. The US computer maker is acquiring Perot Systems for $3.9 billion, a whopping 68 per cent premium. This is a muffled echo of rival Hewlett-Packard’s purchase of EDS for $13.9 billion last May. Both IT services companies even had the same Texan founder, one-time US presidential contender Ross Perot. The difference is that HP bought a leading firm and the numbers stacked up. Dell is paying too much for a second-string company.
The computer maker thinks it can squeeze $300 million in cost cuts from the combination from things like procurement. Moreover, it reckons it can deliver revenue synergies through the sale of additional computer equipment to Perot clients. Both claims seem doubtful. The two firms have little in the way of overlap, so cost cuts will be difficult to achieve. And revenue synergies are often promised but infrequently delivered in mergers.
Investors certainly seem to be sceptical about value creation — they chopped $1.5 billion off Dell's market capitalisation on Monday morning, nearly equivalent to the $1.7 billion premium the company agreed to pay.
Looked at another way, Perot is expected to have about $200 million of profits in 2010. Adjust the purchase price for the net cash on its books, and Dell might receive about a 5 per cent return on its investment — probably less than either company's cost of capital.
The bigger problem, though, may relate to Dell's strategic challenges. It achieved success pioneering cheap, bland computers that were assembled to order. But PCs have become so cheap that Dell’s price advantage is minimal, so it is searching for a new approach.
Customers do want IT systems that work. So for Dell to ramp up its IT services to better compete against IBM and HP sounds reasonable. Unfortunately, the pool of companies in the sector has already been heavily fished. Even if Dell can steer Perot Systems successfully, the services divisions of its two big rivals will still be far larger.
So more acquisitions appear likely — indeed, Dell mentioned “bolting on” other assets. Buying more smallish companies at high prices might obscure the company's floundering. But it'll take something more radical to set a new course.
