Dell to Buy Perot Systems in Bid for Enterprise Market Share

Dell’s $3.9 billion bid for Perot Systems shows how far the company must go to adequately compete in the enterprise market against IBM and HP. But better to pay a premium for a service provider than to continue being largely a commodity PC vendor, which won’t help return the company’s margins to their former glory days.

Both boards have approved the deal and it won’t need financing, so there are a couple of hurdles passed. According to the Wall Street Journal, Dell will pay a significant premium for the shares:

Dell will begin a tender offer to buy all the Class A shares of Perot for $30 a share, a 68% premium to Perot’s closing price Friday of $17.91. Perot’s Class A shares haven’t been above $30 for more than a decade.

Apparently when HP bought EDS last year, ironically also started by Ross Perot, its $13.9 billion price was only a 33 percent premium. So Dell is paying a smaller number, but had to offer a bigger boost per share.

However, there’s a good reason. Dell once made enviable margins, but, according to my sources, largely because it was arm-twisting its suppliers into selling at a miniscule mark-up and making their profits from other customers. That effectively let Dell absorb the profits of the entire supply chain. Back in 2004, although Dell’s gross profit margins were around the industry average, operating margin was running close to 9 percent, which was 3 percentage points ahead of its rivals. Around then, in a talk at MIT, Michael Dell said, “We look at markets that are large, with opportunities for profit, which means inefficiencies in how the [products are sold].”

But there is relatively little inefficiency these days and suppliers are no longer willing to give up their margins so Dell might be successful. That means if it’s going to make enough money to keep investors happy, it must find a more profitable business. All it had to do was look at IBM and HP. The former made the shift from hardware vendors to service provider in a big way years ago, pulling itself out of the doldrums. And as I noted last month, HP has been changing its business mix to strongly emphasize services. The only bright spot in its earnings has been the EDS acquisition.

Clearly Dell has been gearing up for acquisitions. It didn’t have that many choices in terms of a company it could acquire that would have consulting muscle enough to at least give it a chance at getting enterprise business, and certainly Perot Systems was one of the potential candidates.

But HP and IBM already had far more significant service operations when they expanded their offerings than Dell currently has. So Dell management faces the question of whether it will listen to the service experts they’re hiring and run the business the way it will need to be run. If not, then the company will have found itself spending money with nothing to show.

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