Should Microsoft Buy Dell?

| About: Microsoft Corporation (MSFT)

Just yesterday I said that I expected someone else to join the bidding war for Dell (NASDAQ:DELL), alongside Michael Dell and Silver Lake Management. While we have yet to see official LBO interest for Dell from other financial firms, Microsoft's (NASDAQ:MSFT) sudden interest to finance part of the deal was not really what I had in mind, and puts a different twist on the whole matter.

There is an inherit conflict of interest if Microsoft buys a piece of Dell that might do more harm to Microsoft than good, unless Microsoft goes all the way. Let me explain.

For argument's sake, let's say Microsoft decides to buy Dell altogether. Immediately if it wants it could create a worldwide monopoly. How you ask? Microsoft can - if it chooses - stop licensing its operating system to PC manufacturers and be the only kid on the block making PCs. Even if it doesn't choose to do this, it can increase licensing fees it charges OEM manufactures by a lot and have a competitive advantage over everyone else.

If Microsoft pursues this route, then it will put other PC manufacturers at a great disadvantage. Imagine for example, if Microsoft increases Windows 8 licensing fees to Hewlett-Packard (NYSE:HPQ) and Lenovo (OTCPK:LNVGY) by 300%. How will the two companies compete with Dell and Microsoft?

But in order for Microsoft to do this, Dell needs to have the capacity to manufacture PCs on a monumental scale. Dell does not have this capacity. Of course, Dell can outsource much of this production, but I don't know how that will work when most of that outsourcing will be funneled to companies that were just destroyed by Microsoft.

Having said this, however, assuming Microsoft were to buy Dell, then Microsoft will command hardware margins similar to Apple, absent any competition in the PC hardware space.

Easier said than done

If Microsoft decided to take such a route, then other operating systems such as Linux would gain in popularity. Since PC manufacturers would not be able to license Windows, Linux would be the alternative choice. So all those PC manufacturers who sell Windows machines today would sell Linux machines. So on the one hand, Microsoft's profits would rise in the short term, but on the other hand, there is the possibility that it will cannibalize its operating system over the long term.

Also, it is doubtful if antitrust regulators will allow Microsoft to make such a move. Even if U.S. lawmakers allowed it, I am sure that European antitrust regulators and many other counties would prevent Microsoft from making such a move.

Microsoft has already made the first move

Having said all this, Microsoft is already openly competing with its licensing partners with the introduction of Microsoft Surface RT.

If you haven't noticed, it is the first time Microsoft is putting its name on a piece of hardware that runs its own software. Never in the past has Microsoft done this. And while it is not threatening anyone yet, the simple fact that it is competing with other Windows licensing partners is a deviation from its long time practice. And if I were an OEM PC manufacturer, I would be a little nervous.

So the fact that Microsoft wants to provide some sort of financing to the Dell LBO deal leads me to believe that Microsoft is actually trying to get into the hardware business from the back door.

Assuming U.S. antitrust regulators let Microsoft finance part of this deal, it means that Microsoft will be able to do all kind of deals with Dell, especially on the enterprise side. Let me remind you that Dell and Microsoft already have a long time enterprise relationship. This partnership will add more strain to Dell's enterprise competition, even if Microsoft doesn't buy all of Dell in the future. It will also open doors for opportunities to both companies in ways we can't imagine at the moment.

If all works well, and if no one brings antitrust issues against Microsoft, Microsoft can probably buy a bigger piece of Dell in the future - or buy all of Dell outright - and establish itself as a hardware manufacturer also.

Bottom line

I don't know if this is what Microsoft has in mind, but if it is, assuming antitrust authorities let them proceed, entering the hardware business might be the best long-term move Microsoft can make.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Problem with this article? Please tell us. Disagree with this article? .