Microsoft's $2 Billion Dell Deal May Play Out Like The Software Giant's Partnership With Nokia

Aug. 1.13 | About: Dell Inc. (DELL)

Dell (NASDAQ:DELL) is now at a critical inflection point in its history. Never before has the revered PC maker, the third-largest in the world in terms of PC market share, faced such a grueling test as it is does right now with the planned privatization. Lenovo holds pole position and commands a 16.8% market share while HP (NYSE:HPQ) follows closely in second place with 16.7% of the market. Dell is in third place with an 11.8% market share, according to a recent report released by the Gartner Group.

That Dell actually needs to go private is really a foregone conclusion; this is the only sure way that Michael Dell, the company's eponymous founder, will finally get the much-needed free rein to drastically reorganize and restructure Dell from deep within, from the PC and device manufacturer it now is, to a solutions provider. Dell's present situation closely mirrors that of IBM (NYSE:IBM) a few years ago. Both HP and Dell had managed to carve a formidable niche as PC titans- that is, until the PC landscape underwent revolutionary changes. IBM managed to pull off a rare feat for a behemoth of its size and responded to the industry-wide tightening hardware margins by transforming itself from its traditional mainstream hardware business to become a ''services and solutions'' provider. IBM's greatest milestone in the transition came in 2004 when it finally sold off its core PC business to China's Lenovo

Dell PC-Maker image still lingers

Dell has, however, had little success so far in shaking off the PC-manufacturer image. The company has spent billions of dollars since 2008 dollars in acquisitions of companies such as Quest Software, AppsAssure and SonicWall Quest in a bid to change into a solutions company and now brands itself as management software, cloud computing and converged infrastructure data centers provider. Despite the bold move, Dell's PC-manufacturer tag still lingers and has stubbornly refused to go. One major indicator that tells you that Dell is just a pale shadow of its former self is the way its shares have tanked over the years. Dell's shares traded around $12.66 on July 31, 2013.This is far below the $30s range the shares traded in 2007 and much less than the $54 mark recorded in 2000.Dell certainly needs to reinvent itself if it is to remain relevant in the face of the rapidly-changing IT world.

Microsoft (NASDAQ:MSFT) has agreed to advance Dell a $2 billion loan to facilitate its $24.4 billion leveraged buyout. Microsoft's investment in Dell will help the software titan maintain a strong influence in Dell, one of its chief Windows customers. Microsoft opted to invest in debt rather than share equity in a bid to play it safe and cover its tails just in case Dell flounders in the transition. By so doing, Microsoft performed a rather delicate balancing act by ensuring it kept its entire PC ecosystem of companies happy by avoiding creating the impression that it was playing favorites.

Microsoft strained its delicate ties with its major PC-manufacturer partners after it released the Surface Tablet; a device that competes directly with other tablets and traditional desktop PCs. Its investment in Dell could potentially further exacerbate the existing tension with other PC manufacturers if the latter see the deal as conferring an unfair advantage to Dell. Microsoft is definitely keen to keep all its principle OS customers in the pink of health, now that they face severe competition from other OSs such as Linux and companies such as Google (NASDAQ:GOOG). But how the company goes about doing this might cause unforeseen problems for it.

Situation now reminiscent of the Nokia deal

Microsoft sunk billions of dollars in February 2011 into its Nokia (NYSE:NOK) deal to keep the mobile phone manufacturer from bawling over. The Nokia partnership was seen as Microsoft's way of keeping Nokia loyal to its Windows Phone platform, and, of course, shut-out all other competing OSs such as Google's Android, which posed a major threat. In the new Dell-Microsoft deal, Microsoft is now probably keen to keep Dell loyal to Windows and prevent it from straying into one or several of the numerous enemy camps including Linux, Chrome OS, Android and others.

When you take time to scrutinize the Dell-Microsoft deal further, yet another interesting parallel comes to light. The Nokia deal was met with cold suspicion by many insiders and industry players and there was plenty of debate about whether this partnership would confer an unfair advantage to Nokia. The Dell-Microsoft deal is facing similar concerns about whether this will give Dell an unfair advantage, including, but not limited to, privileges such as accessing an early look glimpse into new Microsoft software releases or an unfair preference by Microsoft during its product promotions. Just how genuine are these fears? To try and gauge that, let us now take a peek at the Nokia-Microsoft partnership.

How well has the much publicized Nokia-Microsoft deal played-out until now? Honestly, not too well. Nokia was initially expected to bring its expertise in hardware design and language support to the deal table and help Microsoft to bring its Windows Phone to more price points ranges, introduce it to larger geographies and more diverse market segments. Industry insiders, however, did not buy into this school of thought and criticized the partnership as relegating other Windows Phone companies such as Dell, HTC and Samsung to mere second-class partners in Microsoft's Windows Phone ecosystem. Microsoft was eager to make the partnership work and came out of the stalls guns blazing. The firm's major strategy was to push Nokia's Lumia platform as its principle Windows Phone flag-bearer. But the bid fell flat on its face and since then, Microsoft's ardor for the Nokia Lumia has cooled off, and the firm is now eager to shares the love with several other Windows Phone manufacturers too. Microsoft recently picked HTC as its signature Windows Phone partner. HTC now uses ''Windows Phone'' in its official name; this is something that Nokia never did.

Microsoft recently picked Huawei in the 4 Africa African-Development initiative, contrary to many industry insiders' expectations that Nokia was best-suited for the role owing to its proven track-record in emerging markets.

Dell to venture into enterprise software services

Dell's operating margin stands at just 5.74%. In sharp contrast, Microsoft enjoys more than 36% operating margins from bundled software sales. Microsoft has the potential to grow its software sales using the Dell legacy business. Judging from the way the Nokia-Microsoft deal has played out up to this point, there is really no reason for other PC OEMs to panic that Dell will be unfairly favored by its partnership with Microsoft. In fact, chances are that Dell will likely only end up being a convenient factory for Microsoft's Surface Tablets or only emerge as a more powerful Windows OEM partner for the software giant. The biggest way that Dell can potentially benefit from the deal is if it does finally succeed in transforming itself into a solutions company as it hopes to do, it will gel nicely with Microsoft's software services division, currently one the firm's fastest-growing divisions. The rapidly-declining PC industry (average industry sales down 10.9% last quarter) will provide headwinds for Dell and other PC manufacturers and it is not a stretch to predict that several PC companies will eventually be wiped off the slate in a few years' time, and the ones that survive will probably only be backing Windows just to hedge their bets.

Failed takeover bid

The concerns that have been circulating among industry insiders that the Dell-Microsoft deal will unfairly favor Dell are, therefore, largely unmerited. That said, investors still need to carefully weigh their options before buying or selling Dell shares. Right now, the takeover bid is far from guaranteed. Some analysts think that if the privatization bid fails, Dell shares might actually appreciate considerably on the strength of renewed confidence in the new management spearheaded by Carl Icahn. On the flip side, if the bid fails, some analysts such as Deutsche Bank have slated Dell shares to plummet to just $9.Chances of a failed bid are high and I think the latter scenario is the more likely of the two. Sell the shares now.

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.