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By | Timothy Prickett Morgan 21st September 2009 17:42

Dell plus Perot - It's a start

But what about the finish?

Analysis Dell's $3.9bn acquisition of Perot Systems comes after two years of sweet talking by Dell chairman and chief executive officer, Michael Dell. While adding the Perot services business to Dell's own will certainly help the PC, server, and storage maker on a number of fronts, the acquisition will almost certainly not be the last acquisition by Dell as it takes on bigger players in the IT racket.

In a conference call this morning after the announcement of the deal, Dell (the man) said that this was "the right acquisition" for the company to make, one that he started pursuing in 2007 with Ross Perot Jr., the son of the company's founder, former presidential candidate, former IBMer, and founder of Electronic Data Systems. "This has not been a new idea," Dell said in the call. And he added that David Johnson, the ex-IBMer and mergers and acquisition expert that Dell hired earlier this year, prompting a lawsuit from Big Blue, was not involved with the deal.

Dell said that over the summer, talks between himself and Ross Perot Jr. intensified and that the two worked out a deal that gave Perot Systems the premium that the Perot family and other key shareholders wanted (67.5 per cent above last Friday's closing stock price and 50 per cent larger than annualized revenue) as well as an agreement by the key leadership of Perot Systems to stay on board after the acquisition.

EDS, you will remember, was the first standalone services company, founded in 1962 after the original Henry Ross Perot floated the idea to his bosses at Big Blue and they rejected the idea. (This is the same IBM, after all, that once thought maybe a handful of electronic computers would be installed worldwide). After selling off EDS to car maker General Motors in 1984 for $2.4bn, Perot (the father) hung around the GM board being a gadfly until GM decided to rid itself of EDS through a spinout in 1996.

Last May, Hewlett-Packard shelled out $13.9bn to acquire EDS, with an army of 136,000 employees, yielding an overall HP services business with $38bn in global sales and 210,000 employees. (Well, before the layoffs started, anyway). In 1988, Perot (the father) started a new IT consulting company from scratch, and it has been growing steadily over the past two decades. But Perot Systems is still utterly dwarfed by the services businesses of HP and IBM.

What Dell and Perot Systems announced today is just a fun-size version of the HP-EDS deal, and it doesn't look like Dell is interested in layoffs on the scale of the 24,600 that HP instituted in the wake of its EDS acquisition. Dell said that the combined services units of his company and Perot Systems had a cost base of about $4bn and that somewhere around 6 to 8 per cent of those costs could be wrung out over two years through reduced IT spending (now Perot Systems will get X64 servers and storage at cost), shared delivery models, and other synergies. And, Dell said, these savings would be reinvested in growing the services business, which will be now located not in the Round Rock headquarters for Dell outside of Austin, Texas, but in the Plano, Texas, suburb north of Dallas.

Dell's enterprise services business, you might be surprised to learn, is already nearly twice as large as the aggregate revenue stream from Perot Systems. In the prior four quarters, Dell has booked $5.1bn in services revenues, compared to Perot Systems' $2.6bn in revenues. Dell's chairman said that about 71 per cent of the company's services revenues come from product support, which is about $3.6bn.

So true IT services - installing and managing systems for people - only accounts for $1.5bn on an annual basis for Dell over the past twelve months. Of that $1.5bn, about $410m comes from consulting and just over $1bn comes from product lifecycle management services - meaning upgrades and garbage disposal. So what the Perot Systems deal really means is that Dell will be able to increase its real professional services business by a factor of six.

Eight billion dollar backlog

Perot Systems has an $8bn services backlog right now, and Dell itself has a $5.8bn "preferred services" backlog, according to Dell (the man). This may seem like a lot of dough, but it is a tiny fraction of the $132bn services backlog that IBM had as it exited the second quarter of this year. That is more than a year and a third of revenue that Big Blue basically has in the bank.

In the first six months of this year, IBM has brought in $26.6bn in services sales, and maintenance was about 13 per cent of the total, or about $3.5bn. The rest of what IBM does is real services, and that business is over fifteen times as large as the combined "real" services businesses of Dell and Perot Systems put together (provided IBM's final two quarters of 2009 look like the first two).

While Dell (the man) said that the Perot Systems acquisition was the right deal - and merging two Texas companies is usually a good idea, and one that Dell probably should have thought about a decade ago before HP bought Compaq - it is also fair to say that this was the largest services acquisition that Dell could afford. And it is also fair to say that Dell is going to have to make a bunch of niche acquisitions to take on targeted markets like government and healthcare, where Perot Systems is strong but facing intense competition from IBM and HP, who want to get on the economic stimulus gravy train and ride it from Washington to Wall Street.

Ross Perot Jr. said in the call that his M&A team was "very excited" to have access to Dell's balance sheet to do deals for this very reason, since Perot Systems was not large enough itself to do big deals to grow inorganically to take on the competition in services. At the end of June, Perot Systems had $291m in cash and equivalents and $38m in short-term investments. That's not much of a war chest to make big acquisitions, and Perot Systems has not exactly been throwing off bales of cash in the past four quarters, with a net income of $118m over the past four quarters against that $2.6bn in sales (about 4.5 per cent of revenue).

Dell, on the other hand, had $12bn in cash and short-term investments and $3.4bn in debts at the end of July, and it will still have $4.7bn in net cash after doing the Perot Systems deal and paying off its debts (if it decides to do that, which it won't so it can do other acquisitions as the economy is still sour).

Perot (the man) said that about 27 per cent of the company's revenue comes from selling services to governments around the globe (the business that made EDS large and that eventually compelled IBM to form an arms-length subsidiary to sell services to the U.S. government) and that it had a very big healthcare practice as well, one with a special emphasis on business process engineering for healthcare providers.

One of the strengths of EDS and Perot Systems over the past two decades is that they have been standalone companies, ones with no obvious ties to any specific platform vendor, even if they did have strong alliances with a few of them. The question now is will the HP acquisition of EDS and the Dell acquisition of Perot Systems hurt sales because of the parent companies' obvious platform preferences - or does it come out to be a net gain? One of the reasons why these two free agents had done well might have been precisely because they were not tied to a vendor, like the IBM, HP, Sun Microsystems, Unisys, and Fujitsu IT services business obviously are.

No matter what, the Perot Systems deal makes Dell bigger and gives it a better toehold in healthcare and government IT. You could hardly find a better place to try to shake up the incumbent platforms. The issue that Dell faces now is that $4.7bn doesn't buy a big enough services company to make Dell more of a key player in this industry. Dell could acquire the services business of Sun from Oracle and maybe acquire the same biz from Unisys and spin out its mainframes to IBM, Fujitsu, or Hitachi. These are moves that Dell can afford. ®

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