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Dell Needs To Acquire Palm

Posted on Monday, Mar 2nd 2009

With demand for PCs declining in the face of the recession, computer manufacturer 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 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.

Chart for Dell Inc. (DELL)

In its earnings call, Dell has 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 or even Research in Motion (RIM) 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.

Chart for Research In Motion Ltd. (RIMM)

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.

Chart for Palm, Inc. (PALM)

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Comments

Good Points. I agree.

The laptops and Smart phones are getting more and more close in the form on Netbooks. At some point I would expect Netbooks to become replacements for laptops at the low end and smartphones at the high end.

Palm can bring much needed inovation engine at Dell; which Dell sorely needs. The key to make this acquisition work will be to make sure Dell does not kill the innovative spirit at Palm.

Haresh

Haresh Vaishnav Monday, March 2, 2009 at 10:19 AM PT

I think this acquisition does make sense.

I feel that post merger, Dell should work on a platform which makes data availability and collaboration seamless and effortless between the desktop/laptop and the handheld.

This will make them stand out and shine brighter among all other hardware manufacturers as it will solve real life problem!

Abhishek

Abhishek Rungta Tuesday, March 3, 2009 at 2:47 PM PT

Dear Sramana,

PALM costs $800m equity at the 109m share count. However Elevation’s options kick in above the ~$8 range, moving the market cap to the $1.5b range. On top of that, there’s a $400m term loan for a total cost of ~$2b.

Two billion dollars for a company that has a track record of losing cash.

Dell would be better off picking up the WebOS IP out of bankruptcy. The Pre is just a HTC Touch knockoff (that expects a dying company, Sprint, to somehow pay an above market ASP).

—-

Your trend insights are good, and your interviews are excellent. Without rancor, I’d strongly recommend reading Nairn’s “Engines that move markets”, and Klarman’s “Margin of Safety” in the context of making stock recommendations.

Shalimar Tuesday, March 3, 2009 at 10:12 PM PT

Shalimar,

I disagree with your Palm analysis. I don’t believe Dell will be able to bring a Smartphone to market on its own. Nothing else other than Palm is available at any reasonable price.

RIM+Dell is another option, but more complex.

Thanks for the recommendations.

Sramana Mitra Tuesday, March 3, 2009 at 10:47 PM PT