Dell Needs to Acquire Palm

With demand for PCs declining in the face of the recession, computer manufacturer Dell (DELL) on Thursday reported a 48% drop in profits and 16% drop in sales in its Q409 results. It missed revenue estimates but beat profit estimates, helped by a 16% reduction in operational expenses and strong cash flow. Let’s take a closer look.

Q4 revenue was down 16% to $13.4 billion, missing analyst estimates of $14.1 billion. Net income was down 48% to $351 million or $0.18 per share. Excluding charges, EPS was $0.29 per share, beating analyst estimates of $0.28 per share.

Gross margin declined to 17.2%, from 18.8% in Q3 and 18.7% in Q408. Cash flow from operations was $729 million. The company has cut operating expenses by 16% through a shift towards using contract manufacturers to build more of its laptops as well as through layoffs and the shutdown of manufacturing plants. Its average cost per box has been reduced by 5%. Headcount was down 11% to 78,900. Dell has now increased its 2011 cost-reduction goal from $3 billion to $4 billion.

By product category, revenue from Desktop PCs was down 27% to $3.5 billion. Mobility revenue was down 17% both y-o-y and q-o-q to $4 billion. Dell is focusing on the netbook market (which currently seems to be the rage) by selling 3G netbooks. Software and Peripheral revenue was down 6% to $2.48 billion. Servers and Networking revenue declined 16% to $1.37 billion. Services revenue was $1.35 billion, down 3%. Storage revenue was the only category to show growth (7% to $692 million).

By region, revenues were down 17% both y-o-y and q-o-q in the Americas commercial unit; 17% y-o-y and 7% q-o-q in EMEA commercial; 24% y-o-y and 21% q-o-q in Asia-Pacific commercial; and down 7% y-o-y and up 4% q-o-q in global consumer. Total revenue from the BRIC countries, accounting for 7% of Dell’s global revenue, was down 23%.

Revenue for fiscal 2009 was $61.1 billion, almost the same as last year. Net income was down 16% to $2.5 billion or $1.25 per share. For the full year cash flow from operations was $1.9 billion. The company ended the quarter and the year with $9.5 billion in cash and investments. Dell is currently trading around $8 with a market cap of around $17 billion.

On its earnings call, Dell said that it will be looking for acquisitions. In my last post, I said Dell should make a smartphone acquisition. As we saw in the Handset Sector Overview, the convergence device sector is still expected to grow, though not at the earlier pace. However, according to Gartner, PC units are expected to see their worst decline in 2009. There is therefore a growing need for Dell to come up with a convergence device strategy. Palm (PALM) or even Research in Motion (RIMM) would be good targets. Let’s see why.

RIM has annual revenue of about $6 billion and an established presence in the enterprise smartphone space with market share of about 16%. If Dell is to enter the smartphone and convergence device game, it will be starting off with the enterprise market, where RIM reigns. Acquiring RIM would make better sense for Dell to increase its market share, build upon RIM’s strongholds and come up with an ultimate convergence device. However, RIM has a market cap of about $23 billion and is trading around $40. A Dell-RIM merger may happen, but not easily.

Palm is more affordable and lucrative, with a market cap of about $800 million on annual revenue of $1.3 billion. It is about to launch the much-awaited Palm Pre, which has revived the stock from about $1 in December to about $7. The Palm Pre not only has an exceptional design (somewhat like the iPhone) but also a great OS, just what is needed to challenge the iPhone. The latest news is that Palm is dumping its good old Palm OS for the Pre’s Web OS. I have been long rooting for a Palm-Dell marriage, and now seems to be the right time. Jon Rubinstein, a talented former Apple executive and the father of the iPod is executive chairman at Palm, and if Dell can also lure him to come with the deal, it would be an excellent way to rev up Dell’s non-existent but urgent need for a credible smartphone strategy.

Comments

[Yagottabe K...:]

If Dell acquires Palm, short it into the ground.

What a silly idea.

Palm is losing money bigtime. The Pre isn't close to release. Palm's only phone is the Treo Pro (a nice Wndows Mobile phone - one of a cast of thousands available).

Dell has been talking to the same folks that make Palm's phones, in Taiwan, for years. all they need to do - ALL they need to do - is contract with those same ODMs.

Won;t cost billions (!!!) of dollars like a Palm purchase.

What a silly idea.

Mar 03 06:55 AM

[User 368585:]

I think author should learn to focus more on details and math regardless of what her thought is on "strategy." Strategy without finance skills is worthless and this is a perfect example.

While Palm has a market cap of roughly $800MM, take out price would be much greater due to preferred stock and debt. There is $325MM of preferreds that convertes at $8.50. Questionable if that would convert. Another $100MM of converts that convert at around $3.50 (might be $3.25, but close enough for the quick calc). There are 110MM shares outstanding (and I'm not even including options). At current share price of $7.40 and assuming a takeover premium of 30%, then it gets to ($7.40*110MM+$7.40*30.... debt. That works to about $1.7B - NOT $800MM as author mindlessly suggests as rough acquisition cost.

There isn't much cash and Palm will burn at least $100MM and needs the rest for working capital. Therefore, little of it can be used to offset the deal. The revenues aren't worth much because A) it's all centro which is a virtually unprofitable and B) last quarter revenues were down 40% Q/Q (!!!!). So, that centro revenue stream is going away. They still haven't launched Pro in the US even though the phone has been out for quite some time due to the company's inability to get bugs worked out - which if you remember, the 800W also had delays and other prior Treo phones have had delays. So, what author is suggesting to buy a company with a phone that no one has made a call with yet outside company reps demoing phone (not even released) with no known distribution besides Sprint (which Dell could do themselves) with a company with a historically questionable ability to get phones into markets. And as the prior poster noted... I haven't even touched cash burn.

Would you really want to be the corp dev guy at Dell that suggests this acquisition to Michael Dell during the biggest consumer led recession that we've had in quite some time. For context, Dell has a $16B market cap and $6B net cash as of 10/31/08. So, author is suggesting Dell blow almost 1/3 of their cash on that acquisition. And RIMM? RIMM has a $20B market cap and again, assuming a 30% premium, a takeout value of $26B. The author is really delusional if this individual believes that Dell should buy RIMM. Maybe the argument is that RIMM should buy Dell at these valuations.

Please learn to do math before throwing out these random blogs that aren't grounded in reality. As I said earlier, strategy is nice, but valuations and cash are more important too!

Mar 03 10:12 AM

[mollytjm:]

isn't this sort of like k-mart buying Sears? i guess there's a dim hope for survival, but it's REALLY dim. Dell needs to spend it's money on innovation and tech support...here. They lost enormous market share by outsourcing their tech support to the lowest bidder.
their only innovation this year is color...not great for a tech company. and Palm innovates very slowly... combine the two when neither company manages innovation very well... can't see how that will work. They each need to partner with someone innovative or learn how to invent.
I'm long APPL and happy.

Mar 03 10:25 AM

[Marcap:]

I think a Dell / Palm merger would be great for both companies.

Quite often companies do much better after they are merged or one is taken over, than they were doing previously, since not only is management often changed, but the additional products complement one another. Two examples of this would be HP + Compaq and eBay + PayPal. Now I'm not sure that one from either couple would do as well without the other.

Would a Palm takeover or merger help Dell? I think so, since there would really be really no significant additional cost to Dell to promote Palm, just as it now offers digital cameras, printers, GPS units, and so on. And Palm does have a great name in PDAs, even though Palm may not be doing very well financially. In Palm's case, I think the financial problems Palm is having are much more the fault of management and marketing, than it is the fault of their actual products.

Mar 03 11:19 AM

[User 368585:]

I can also point out even more mergers that failed. So, the argument that companies that merge often times are better off is a bit of a weird argument. A bit of too broad of a statement to really be helpful for anything beyond being a red herring.

Marcap's argument about channel doesn't hold since the channels for cell phones are vastly different than Dell's traditional direct model. There would be an additional cost for Dell to promote Palm since they would have to keep (if not improve) the Palm sales force and learn to work with carriers. If Palm were still a PDA vendor, then that thesis would be correct.

I do agree the fundamental problem is management. The second fundamental issue is scale. A Dell merger with Palm would help the situation though, but challenge is that the cost of the acquisition could take down Dell's cash enough that the combined entity could become not so well capitalized. Dell has been moving towards a more indirect channel and I fear that it might consume more cash and buying Palm would just exasperate that situation and ultimately weaken Dell.

If Palm had a runaway hit, then there would be a better argument, but then the Palm acquisition would also be costlier. The other challenge is that the smartphone market is significantly tied to available apps (at least I suspect that's why every smartphone vendor from MSFT to RIMM to GOOG to Samsung and others are announcing marketplaces). Until Palm can prove they can get developer support (and legacy Palm developers who made an app 5 years ago and sit there and collect checks don't count), it's a very dangerous game to play in acquiring Palm. If Palm were cheaper (say $200MM???), then the rationale of buying Palm might make a bit more sense, but at takeout valuation of $1.7B and the current macroeconomic/consumer environment, it becomes very risky for Dell.

At this juncture, Dell really just needs to spend more time minding the store and ensuring survival rather than spending time acquiring another company. Gartner just came out yesterday and said that PC growth would be a -11% in 2009 - even worse than 2008!

Mar 03 11:38 AM

[367851:]

They can buy one of those Palm devices, take it apart and reassemble it with a DELL label. Offer it in 8 different colors.


On Mar 03 06:55 AM Yagottabe Kidding wrote:

> If Dell acquires Palm, short it into the ground.
>
> What a silly idea.
>
> Palm is losing money bigtime. The Pre isn't close to release. Palm's
> only phone is the Treo Pro (a nice Wndows Mobile phone - one of a
> cast of thousands available).
>
> Dell has been talking to the same folks that make Palm's phones,
> in Taiwan, for years. all they need to do - ALL they need to do -
> is contract with those same ODMs.
>
> Won;t cost billions (!!!) of dollars like a Palm purchase.
>
> What a silly idea.

Mar 03 02:09 PM

[Spook:]

Won't be the first time Dell did such a stupid move.

More than 10 years ago, when Dell was starting their notebook business, Dell worked with a Taiwan ODM, Dell didn't like what was happening, so they pull the plug, went to Samsung, and guess what? Samsung act as middle man and brought them back to the same Taiwanese ODM.


On Mar 03 06:55 AM Yagottabe Kidding wrote:

> If Dell acquires Palm, short it into the ground.
>
> What a silly idea.
>
> Palm is losing money bigtime. The Pre isn't close to release. Palm's
> only phone is the Treo Pro (a nice Wndows Mobile phone - one of a
> cast of thousands available).
>
> Dell has been talking to the same folks that make Palm's phones,
> in Taiwan, for years. all they need to do - ALL they need to do -
> is contract with those same ODMs.
>
> Won;t cost billions (!!!) of dollars like a Palm purchase.
>
> What a silly idea.

Mar 03 03:56 PM

[Yagottabe K...:]

Well, Palm just announce a rather significantly more disastrous quarter than even The Pessimists had been predicting AND mentioned the possibility of even further dilution (by issuing stock), probably due to an inability to get further loans.

So they have 180+ megashares out (converting those Preferred) and a stock price of $6.50, MASSIVE debt, and a strong potential to have even more share out.

Dell is going to spend BILLIONS for the Pre?

Mar 03 06:17 PM

[kris23:]

Didnt Pal just report pretty dismal quarter results? I see where you are heading with a merger, but I'm not sure Palm is the right choice. Dell seems like they are stuck in a corner-especially with the forecast for slowing PC demand. Unless Dell begins to innovate more and create new products I think investors will remain bearish (www.predictwallstreet....) on Dell. I'm pretty pessimistic about their short-term future.

Mar 04 02:01 PM