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Dell Wants to Buy EMC. Here's Why.

The deal as proposed would be both expensive and complicated, and aimed squarely at HP.

Justin Sullivan / Getty via Thinkstock

Dell, the personal computer maker that has transformed itself into an IT services company, wants to buy all of EMC in what would amount to the largest tech deal in at least the past decade.

If it goes through, the deal would be incredibly expensive. Dell has proposed $27 a share for EMC, which would make a purchase price that would top $50 billion, according to a source. Just two years ago, Dell went private in a $25 billion buyout, and it would now have to raise more than $40 billion in debt to own EMC. Dell also still carries debt of about $12 billion.

Expensive or not, Dell, led by CEO Michael Dell, would be able to expand its business and gain entry into a key part of the data storage market. It would also get control of the software company VMware. (More on that in a moment.) And for EMC CEO Joe Tucci, this could be the exit strategy he has been seeking for years. His company has come under significant pressure from activist hedge fund Elliott Management to sell off parts of its business as well as make management changes to unlock shareholder value.

But does this deal make any strategic sense? It does on paper. Dell and EMC overlap very little. Dell posts about $56 billion in annual revenue according to an estimate put out today by Goldman Sachs, most of which comes from PC sales and a little of which comes from enterprise storage. EMC is the world leader in storage gear, and for the most part its products don’t overlap with Dell.

“The two businesses are largely complementary,” writes Goldman Sachs analyst Simona Jankowski. Combining them could yield a company with about $80 billion in annual revenue and free cash flow of about $7.7 billion, she writes.

Both PCs and enterprise storage are declining or slow-growing markets. The argument for combining the two is to create a unified vendor for PCs, servers, software and storage. Tucci has long argued that the storage industry and perhaps the wider IT industry is ripe for consolidation.

The concern is that as more corporations adopt cloud storage and cloud computing for their IT needs, there is less reason to spend money on the costly software and hardware upgrades typically offered by established IT companies like EMC. But by consolidating, they can better compete against the lower-cost cloud service companies.

At the same time, these legacy players are jumping into cloud services. EMC spent $1.2 billion to acquire cloud management company Virtustream.

Tucci earlier hinted that EMC might be rolled up in a consolidation that would create a single soup-to-nuts IT vendor. Last year, Tucci tried and failed to sell EMC to HP — the parties couldn’t agree on price. Shortly after their talks ended, Hewlett-Packard decided on a tactic opposite to consolidation and took steps to split in two.

Here’s how the Dell-EMC deal could get done:

Let’s tackle the expensive part first. CNBC’s David Faber reported this morning that talks between Dell and EMC have been ongoing for months. EMC’s current enterprise value is about $48 billion, plus it has combined cash and short-term investments of about $7.7 billion.

Dell borrowed a lot in 2013 to finance its $25 billion buyout with some help from the private equity firm Silver Lake. The credit rating firm Moody’s estimated in February that Dell will have about $13.5 billion in combined debt on its books by the close of its 2016 fiscal year next January. Post-deal let’s call it a combined $53 billion.

Elliott Management, the activist hedge fund that has been pressuring EMC to spin off VMware, the software company it controls, would have to support the deal. Sources familiar with the matter tell Re/code that EMC had asked Elliott for an extension to the standstill agreement between them that expired on Sept. 1. Elliott, sources say, stayed silent, but it’s clear that EMC was asking for time in order to get talks around this potential deal into motion. Elliott could in theory come out publicly in support of or against the plan. Its support will be crucial; its opposition will kill the deal.

There’s another loose piece to all this: How does VMware fit? Under the scenario reported by Faber, Dell would maintain control of VMware. But it’s hard to envision Dell taking over EMC without using VMware to its financial advantage somehow. It could, for instance, sell off about 25 percent of VMware shares in order to raise cash, while still maintaining majority control.

Before news of the talks, VMware was trading at a market valuation of about $35 billion. That works out to about $7 billion for 20 percent. That could help trim the amount of debt Dell would have to take on and perhaps make the financing terms more palatable to debt investors.

One final point: A bid in the range of $27 to $28 per share is arguably low. Goldman Sachs analyst Jankowski estimates EMC is worth closer to $30 or $32 a share. EMC shareholders may conclude that after the failure of the HP deal — and no interest likely from other potential acquirers including Oracle and Cisco — a low bid from Dell is better than no bid at all.

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