Microsoft’s help in going private may not be in Dell’s best interests

In 1997, at the height of his PC-fueled bravado, Dell CEO Michael Dell said publicly that Apple, then in decline, should be dissolved. "I'd shut it down and give the money back to shareholders." Now Apple sits near the pinnacle of the industry, and Dell is looking at giving his company's stockholders their money back—and taking the company private. And it looks like Microsoft is going to give him a hand with that.

Dell is hardly in the kind of shape Apple was in 1997. It is profitable and has billions in cash, while Apple was on the verge of bankruptcy. But Dell is trying to transform his company in a fashion similar to what Steve Jobs undertook in 1997—by shedding the company's consumer brands and focusing on businesses.

The problem Dell has is that its consumer PC business—the very golden goose that laid the golden eggs that bought Dell into its current position in the enterprise market—has instead become an albatross. Dell has been moving away from the metaphorical pelagic waterfowl for years. The last major investment Dell made to shore up its PC business was the acquisition of Alienware in 2006 (on former CEO Kevin Rollins' watch).

When Michael Dell returned as CEO, he hired designers and tried to make Dell's consumer products into Apple-like objects of desire, but he got uneven results. And since Dell's acquisition of Perot Systems in 2009, it has been a steady march away from the desktop business toward being an end-to-end business technology provider.

But the company has gotten nothing but grief in the process from Wall Street. Investors have punished the company by dumping its stock and reducing its market value. As Dell has tried to shift its focus away from the consumer PC business, the stock market has rewarded the company by cutting the company's value by 43 percent over the past five years.

So, it looks like there's one thing left for Dell to do: fire the investors and take the company private in a leveraged buy-out. It's a nuclear option that will cost the company—or the people and companies that put together the buyout—over $20 billion in debt and cash to pull off. And that's before Dell starts restructuring the company radically to compete more effectively in the enterprise business. But will Dell—and by translation, Microsoft—really benefit from the move?

For Microsoft, a cash machine

According to reports from the Wall Street Journal and others, Microsoft is looking to put up as much as $3 billion to finance the deal. The motivations for Microsoft are pretty obvious:

• If it gets a percentage ownership of Dell out of the deal, it could exercise a good deal of influence over Dell's consumer and enterprise business strategies.
• If the money is a loan rather than an investment, it gets a constant revenue stream out of Dell in the form of interest payments—and still has significant influence over Dell's business direction.
• By shoring up Dell, Microsoft preserves another major revenue stream: Windows licenses. And a Dell more focused on the enterprise could help push Office and Windows Server products through consulting and end-to-end solution sales.

And finally, by putting Dell in a position to move more forcefully into the enterprise, Microsoft is also potentially getting them out of the way of Redmond's own Surface consumer products. No matter what form Microsoft's partnership with Dell takes, it's a win—at least if Dell doesn't crater as a result. It's also a potential pain point for other PC makers. Gartner Analyst Michael Gartenberg told Bloomberg, "If you’re a vendor that wasn’t happy with Surface, the idea of Microsoft owning part of Dell is not going to cheer you up."

Dell's upside: freedom?

The desire to get Dell off the public market is understandable—being a publicly traded company can be a pain. In addition to the fickleness of the financial markets, being a public company comes with a lot of additional costs and oversight. Those aren't in and of themselves major cost centers (though for some companies the size of Dell, the cost of Sarbanes-Oxley compliance alone can run into multiple millions of dollars). But they do put a drag on operations and affect planning.

It also means that the company doesn't have to worry about a hostile takeover or "activist" investors coming along and turning over the company's strategy apple cart. For some companies (such as Hewlett-Packard, maybe), that might not be such a bad thing long-term. But the biggest benefit of going private is that Dell could make decisions based on long-term strategic goals instead of basing them on the immediate issues that drive the company's market valuation.

The downside of going private is that it prevents the company from easily making more big acquisitions—not having the ability to treat its stock like cash means that the company will have to buy other companies with, well, cash or cash-equivalents. There are limits to how many ways the company can be split up amongst owners as a privately held firm, so Dell wouldn't be able to swap ownership shares to acquire other companies as easily.

Wall Street: Freedom is slavery

And that's the big reason many on Wall Street have bet against Dell going private—they think the company needs to make more strategic acquisitions to grow. Going private, Sanford C. Bernstein and Co. Analyst Toni Sacconaghi told investors in a note last week, "may require about $4 billion in equity" and would actually make it harder for Dell to move out of the PC business.

Dell also faces a cash mobility problem in going private. The majority of the company's $14-plus billion in cash holdings are trapped overseas to avoid having to pay US taxes. So it will have to spend a good deal of its cash on hand at home on the deal, plus get help from outside—including, most likely, from Michael Dell's own investment fund, as well as from Microsoft.

But the alternatives aren't great either.

It isn't clear how Dell is going to do that as a public company, either, without having to expend more of its warchest or take on debt, considering the direction its stock is headed in—the only reason it has bounced up at all recently is because investors are reacting to news of a potential buyout.

While many analysts think Dell should be using its stock to buy its way out of the PC business—which accounts for 60 percent of Dell's profits right now—some are questioning its move into software and services. Dell's overall sales have been slipping with government and corporate customers, even as they've grown in the small- and medium-business market.

There's a problem with that particular analysis: those sales numbers are based at least partially on PC sales. And while Dell's sales to SMB went up, its profits from those sales went down last quarter like all the others, and large enterprise sales were 26 percent larger than SMB sales.

The other question is whether rapid growth through acquisition is really going to help Dell at this point. After all, rapid growth is what the stock market wants, but it may not be strategically valuable to Dell in the long term. Undertaking research and development with the assets the company has already acquired (like Wyse's Project Ophelia, for example) might have bigger long-term payoffs.

Of course, Microsoft's interests are most likely to keep Dell in the PC business, at least in some form, which may be why Microsoft is looking to get in on Dell's going-private action. After all, a healthy Dell will help Microsoft by preserving some semblance of choice in the Windows PC and tablet market while keeping Windows license revenues flowing. It would also help Microsoft stick to the premium device model it has chosen for Surface.

But is it really in the long-term interest of Dell to stay in consumer PC sales just so it can be a Microsoft sales channel?