Editor’s Note: For two updates to the original article, scroll to the bottom of the page.
In the nineties, at Dell’s Austin manufacturing plant, employees assembled personal computers with crisp efficiency. Every few minutes, an order came down the line and color-coded lights on the appropriate bins switched on, telling the workers which components to install on each computer chassis. An entire PC was custom-built in minutes.
These days, things run less smoothly. The PC market Dell once dominated has been eroded by tablets, a sector that the company has struggled to compete in, and smart phones, where it hasn’t even bothered. As a result, one of Texas’s biggest success stories must show that it can do what few of the state’s tech pioneers have done—change with the times.
Compaq Computer couldn’t do it. BMC Software has been trying for years and now faces a future as uncertain as Dell’s. Only Dallas’s Texas Instruments managed, morphing from oil-field services provider to defense contractor to chip maker. But where TI has a decades-long legacy of strong leaders, Dell has always been an extension of its founder.
The story of the company’s stratospheric rise has been told many times. Michael Dell, a Houston-raised wunderkind—he applied for his high school equivalency exam when he was eight—began the company in his University of Texas dorm room in 1984 and turned it into a tech titan in a decade by offering buyers custom-built computers at a bargain. By 2000, it was selling more than $35 million worth of computer gear a day. For many years it ranked as the best-performing stock on the Nasdaq exchange, and it held on to its lead as the world’s biggest PC maker even after the merger of its two main rivals, Compaq and Hewlett-Packard. It was a pillar of the Central Texas economy for two decades—even today it employs about 14,000 people in the greater Austin area and has been the economic taproot for Round Rock’s explosive growth—and has operations worldwide.
In the past decade, though, Dell has stumbled. In 2004, after having run the company for twenty years and approaching his fortieth birthday, Michael Dell decided to step away. He remained chairman but turned over day-to-day operations to president Kevin Rollins. Almost immediately, growth slowed and Dell’s shares faltered.
During the next few years, Dell endured an embarrassing battery recall, several quarters of poor financial performance, and an accounting scandal that resulted in a $100 million civil penalty against the company and $4 million each against Michael Dell and Rollins.
By 2007, Rollins was out and Michael Dell had returned as chief executive. The company, though, has never been the same. The leadership changes and internal turmoil hit at a critical time. With management distracted, the company was blindsided in a way that Michael Dell had always feared. When I interviewed him in 2001, he told me he worried most about “potentially new technologies that could change the industry.” That’s exactly what happened.
Both the business and consumer tech markets have moved beyond the PC, but Dell remains tethered to it. PCs account for about half of Dell’s sales, and while millions of desktop machines and laptops are still sold by Dell and others every month, the business is in decline. Dell’s latest quarterly profit tumbled 79 percent from the previous quarter, while sales slid 2 percent from a year earlier. PCs have become commodities, a tool as interchangeable as a hammer or screwdriver. Cheap memory and better reliability mean companies and consumers keep their machines longer. Price competition is fierce and profit margins are razor-thin. And the mobile crowd, which is driving the new growth market, can’t be tied down to an old-fashioned “grandpa box.”
With the company’s stock price languishing, longtime investors have become increasingly uneasy. Last year, its biggest independent shareholder, Southeastern Asset Management, suggested that Michael Dell take the company private. That touched off a series of discussions with private equity firms. Silver Lake, a California firm that specializes in technology investments, agreed to participate and eventually put together a bid of $13.65 a share. Southeastern, which was clearly hoping for a higher price when it first raised the buyout idea, decided to challenge the deal and joined with activist investor Carl Icahn to put together its own bid. On July 18, this bidding war culminated in a shareholder vote at Dell’s glass-and-limestone headquarters, in Round Rock. But whatever happened—texas monthly went to press a week before the vote—one thing is clear: Dell must become a completely different company.
That’s a tough move, because other than its talent for squeezing costs and creating manufacturing efficiencies, Dell has never been an innovator. Its research spending has long paled in comparison with that of its major competitors. Yet Michael Dell has spent the past few years steering the company toward the lucrative market for business services—servers, data storage, software, and consulting. The PC landscape is littered with the graves of others who failed to navigate that course. Compaq is gone, Gateway is gone, and IBM sold its PC business to China’s Lenovo.
Redefining its mission is one justification for taking Dell private. It’s not easy to quickly transform a company and keep shareholders happy at the same time. “As a public company, we must take a more cautious approach to our transformation, because we must consider how our stock price will react to the steps we take and what effect that will have on the company and on customers and employees,” Michael Dell told investors recently. “This hurts the speed and efficacy of the transformation and is not good for the long-term health of the company.”
Free from quarterly earnings demands, Michael Dell has argued that he could sacrifice short-term profits and keep an eye on the future, moving the company firmly into business services, which unlike the PC market comes with long-term contracts and a more predictable revenue stream than fickle PC buyers.
Michael Dell has been laying the groundwork for just such a turnaround by embarking on a massive buying spree, starting in 2008 with EqualLogic, which makes data storage gear for big companies. Since then, Dell has made more than a dozen acquisitions, including Dallas-based Perot Systems. Before 2007, Dell had acquired less than half as many companies in its entire history.
“There have been fundamental shifts to the Dell DNA,” said Adrian O’Connell, the research director for Gartner, an IT advisory group. “The Dell that we see today or tomorrow is very different from the Dell we saw ten years ago.”
In all, Dell has spent about $13 billion on acquisitions, yet none have made significant contributions to revenue. It needs the billions it still makes off its grandpa boxes to fund any transition.
To pull this off Dell will have to transform its sales force and integrate all the companies it has bought. This new version of Dell would still make PCs and other hardware, but the company would be focused on selling bundles of equipment and services, designed and maintained to meet the needs of businesses. It’s a little like buying a new HVAC unit for your house: you hire a company not just to install the machinery but to provide the maintenance and advice needed to keep it running.
This isn’t a business Dell is known for. It has to shake off its “Dude, you’re getting a Dell” image and convince potential customers that it can be trusted with maintaining the electronic backbone of their operations.
“It’s a very long-term transition to grow the business across these new areas,” O’Connell said.
Yet there’s something familiar about this move. Once again, Dell is following old rivals into the field in hopes of doing what they do, but more cheaply. IBM has long dominated the services market, and HP has been fighting for a foothold, having bought Electronic Data Systems, the company founded in 1962 by H. Ross Perot. Dell’s acquisition of Perot Systems, the Dallas billionaire’s second act, is the sort of me-too move on which Dell built its hardware prowess.
Now, with HP reeling from its own management turmoil and slogging through a five-year turnaround, Dell hopes to outmaneuver its old rival. Can the strategy work again? The answer may come back to Michael Dell himself and what happens to him after the vote. While he clearly took his eye off the ball in the middle of the past decade, the challenge the company faces plays to his strengths. Tellingly, Icahn had vowed to replace him, perhaps with former Compaq CEO Michael Capellas. That would be a mistake. Capellas is a salesman, and what Dell needs is a leader.
Michael Dell is no salesman, and he’s no Steve Jobs either. He isn’t the domineering CEO, obsessing over form and function. Perhaps because he was so young when he started the business, he assembled a team of experts, including the manufacturing genius Mort Topfer, and listened to them. That helped the company recover from past missteps, such as when it botched the first group of laptops it introduced, in the early nineties.
With this acquisition spree, the company has again amassed expertise from across the computing industry. Whether its founder stays or goes, Dell’s future will once again depend on making the most from the parts that Michael Dell has put together.
Update #1: This article, featured in our August 2013 issue, went to press one week prior to the postponement of the shareholder’s meeting, which was set to take place on Thursday July 18, 2013. The following is Loren Steffy’s response to the news:
Before Dell can move beyond the PC, it has to move beyond its buyout battle. That’s proving more difficult than Michael Dell had anticipated when he first began talks last year to take the computer-maker private.
Dell shareholders were set to vote on his $24.4 billion plan at the company’s Round Rock headquarters Thursday morning. Instead, the company postponed the meeting until July 24, a sign that Michael Dell may not have the support he needs for his deal.
The buyout required votes from 42 percent of Dell’s shareholders excluding Michael himself, who owns about 16 percent of the company. But in recent weeks, his $13.65-a-share offer was trumped by an offer from activist investor Carl Icahn and Dell’s biggest institutional holder, Southeastern Asset Management.
Icahn, who holds just under 9 percent of Dell’s stock, made a bid for $14, although if Icahn is running true to form, he’s less interested in actually buying the company than in forcing Michael Dell to sweeten his deal.
So far, Michael has refused, and it appeared he had prevailed after two key proxy advisory firms, Glass Lewis & Co. and Institutional Shareholder Services, both advised big investors to support the buyout. As the vote came down to the wire, though, institutions that hold more than 20 percent of Dell’s shares said they were opposed, and the jockeying for the remaining votes continued into the wee hours ahead of Thursday’s vote deadline.
Presumably, some of those investors were holding out to see what Michael Dell would do. By pushing the vote back, he gets another week to twist their arms.
Michael Dell is still likely to prevail. It’s rare for management-led deals to fail, especially when ISS and Glass Lewis endorse them. Icahn’s offer has always seemed a bit iffy, his financing has been questioned, his strategy is unclear and his offer price has fluctuated. But big investors also know that Icahn’s track record. His tactics tend to work. Don’t be surprised if Michael Dell coughs up more cash to get his deal done.
Update #2: On August 2, 2013, a special committee announced that Michael Dell and his partner, the investor firm Silver Lake, amended their buyout agreement in a move that some anticipate will please shareholders enough to ensure Dell can take his computer company private. The fight continues, but not without some savvy business thrusts and parries.
Michael Dell has faced down his Kobayashi Maru moment. For those who don’t speak geek, Kobayashi Maru was the “no-win scenario” from Star Trek that was supposed to teach aspiring starship captains how to make decisions when all the options they must choose from are bad.
In his bid to take his computer company private, last month Michael Dell found himself without the votes to ensure he succeeded, a board committee that was demanding he raise his bid, and a hostile shareholder threatening his own takeover that would have left Austin’s billionaire boy wonder on the street. Even this week, activist investor Carl Icahn was filing suit in Delaware court trying to block Michael Dell’s latest moves. Were Icahn to succeed, he would likely split the board but lack the votes to oust Michael Dell, leaving a bitterly divided company that would be in far worse shape than it now.
Last night, Michael Dell took a page from Star Trek lore and rewrote the rules, just as Captain Kirk did to pass the Kobayashi Maru test. Dell convinced the board to change the way it counted votes from shareholders. Under the original deal, shareholders who didn’t vote would be added to the “no” column. Michael Dell had urged the board to count those abstentions as “yes” votes. Instead, the board decided it simply wouldn’t count them at all.
In exchange, Michael Dell sweetened his deal from his last offer of $13.75 a share to the equivalent of $13.88, bringing the value of the buyout to $28.8 billion. The move essentially clinches the deal for Dell, although this isn’t Icahn’s first rodeo. He may have a few more tricks up his sleeve before shareholders finally get to vote at a thrice-rescheduled meeting that is now set for September 12. In a regulatory filing, Icahn vowed to keep fighting, saying that although Michael Dell had raised his bid, the offer was still “an insult to shareholders.” Icahn also said the board’s decision to change the voting rules amounted to it “improperly putting its thumb on the scales in favor of Mr. Dell’s offer.”
The Dell deal shows how pliable shareholder rights are. There are no regulatory requirements or laws that state how shareholder votes must be counted. Companies can, and do, change the rules to suit their needs. Early on, Dell’s board had decided that Michael Dell’s 15.7 percent stake in the company wouldn’t be included in the vote. Given its latest decision on abstentions, the deal may not even need support from a majority of shareholders to succeed.
Going private is Dell’s best option for survival. Getting there has sparked one of the messier corporate buyout battles in history. During Dell’s heyday in the nineties, many investors learned the hard way the folly of betting against Michael Dell. Just a few days ago, it appeared he was facing a no-win scenario. Already a geek icon in his own right, he instead extricated himself just as Captain Kirk once did.
When asked why he cheated on the Kobayashi Maru test, Kirk said: “I don’t like to lose.” Neither, it seems, does Michael Dell.
Loren Steffy, an author and former business columnist for the Houston Chronicle, is a senior writer for the communications firm 30 Point Strategies and a contributor to Forbes.