Dell buys EMC for $67 billion: Will bigger be better?

Dell acquires EMC in a deal that creates the largest privately held technology company. The combined entity, which will be run by Michael Dell, is betting scale will sell to enterprises.

Dell said it will acquire EMC for about $67 billion in cash and stock in what equates to a bet that bigger is better in enterprise technology and hybrid data centers.

The combination of Dell and EMC will create the largest "privately-controlled, integrated technology company."

Here's the big question: Will bigger necessarily be better for enterprise customers? EMC and Dell are creating a mega-vendor just as other technology players such as Hewlett-Packard and eBay are splitting up to compete with nimbler rivals.

EMC shareholders will get $24.05 a share in cash and a tracking stock that represents VMware. EMC owns a majority stake in the virtualization giant. EMC shareholders will get 0.111 shares of the VMware tracking stock for each EMC share they own.

Add it up and EMC shareholders get about $33.15 a share in cash and the tracking stock of VMware, which remains a publicly traded independent company. Dell plans to increase its interest in VMware over time.

The deal, which is expected to close in mid-2016, is financed via equity from Michael Dell, MSD Partners, Silver Lake, and Temasek, debt financing, cash and the issuing of the tracking stock. Dell and his partners will own 70 percent of the combined company.

Dell will remain CEO and chairman. EMC's CEO Joe Tucci will stick around until the deal closes. In a letter to customers, Dell said:

We are bringing together Dell's strength in small-business and the mid-market with EMC's strength in large enterprises. Together, we can serve you better and fuel innovation across our end-to-end portfolio of solutions and across customer segments to generate significant cash flows. In fact, the expected revenue synergies of our combination are three times the cost synergies. This union is all about opportunity, growth and innovation for us and for you. We will be positioned to meet our obligations and continue to invest for the long term success of your organization.

On a conference call, Tucci said "we are entering a new era where the IT landscape is seeing massive disruption and vast opportunities." Tucci said the Dell merger was the best way to position EMC for the future.

"We will have complementary market portfolios," said Tucci.

Key points:

  • Pivotal will operate as it is now under current leadership.
  • VMware will remain independent.
  • The combined company can have $1 billion in synergies.
  • The companies will look to grow converged infrastructure, cloud and data center businesses.
  • EMC's core businesses will remain based in Hopkinton, Mass.

With the move, Michael Dell largely transforms his company, which went private to diversify the business away from PCs.

The EMC acquisition will do the trick. The combined company aims to be a leading enterprise player in the following markets:

  • Servers;
  • Storage;
  • Virtualization via VMware;
  • Converged infrastructure (EMC owns VCE);
  • Hybrid cloud;
  • Mobile;
  • And security via RSA, which is owned by EMC.

The combined company will also have a big data play via its Pivotal unit. The lineup in the combined company will go from various end points right to the data center.

Ultimately, EMC and Dell are going to have to combine their wares in an integrated way. EMC's federation approach was a handicap for enterprise customers and the narrative was hard to follow.

Dell noted that the companies are complementary and will be able to invest in research and development. Dell made a point throughout its statement to point out EMC's Virtustream unit. That emphasis is worth noting since EMC acquired Virtustream to build out a managed cloud business. To play to the hybrid cloud market, EMC and Dell will both need a public compute story.

"Our investments in R&D and innovation along with our privately-controlled structure will give us unmatched scale, strength and flexibility, deepening our relationships with customers of all sizes," said Dell.

Putting the parts together

One thing worth noting about the Dell-EMC merger announcement is that the financial disclosure was lacking. Usually companies provided combined revenue figures and synergy possibilities. EMC and VMware executives talked about their financials, but Michael Dell wasn't on the conference call.

Since Dell is private, its side of the revenue equation wasn't detailed.

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Jefferies analyst James Kisner has modeled some scenarios and estimates that the combined company will have revenue between $74 billion and $76.5 billion. That estimate is based on a partial VMware spin off, which may be similar to the tracking stock arrangement.

R&D will likely be about 5 percent of revenue in the combined companies. Total debt for the combined company may be in the $50 billion to $53 billion range, according to Kisner. It remains to be seen if that debt load is an issue over time.

As the deal was announced, both EMC and VMware outlined third quarter results.

EMC said its third quarter revenue will be between $6.05 billion and $6.08 billion with non-GAAP earnings of about 43 cents a share. That tally fell short of expectations. Wall Street was looking for revenue of $6.24 billion with non-GAAP earnings of 45 cents a share.

However, EMC did note that there was a build in unshipped storage product orders. Those bookings will show up in the fourth quarter. That development hurt earnings by 2 cents a share.

VMware raised its outlook for the third quarter on Monday, as the company aims to show it can continue to execute while parent EMC and Dell prepare their merger.

The company said its third quarter revenue will be $1.67 billion, up 10 percent from a year ago with non-GAAP earnings of $1.02 a share. CFO Jonathan Chadwick said that VMware was pleased with results and revenue growth would have been 14 percent in constant currency. VMware's net income for the third quarter will be about 60 cents a share.

Wall Street was looking for revenue of $1.66 billion with non-GAAP earnings of 99 cents a share.

The two outlooks from EMC and VMware highlight that the combined company will have to manage a slower growth storage business and depend on software defined data center licenses for revenue gains. Dell's real rationale for the EMC purchase may ultimately be VMware in terms of value creation.

Executives said that Dell intends to acquire more of an economic interest in VMware over time.

The questions ahead

On the surface, EMC and Dell fit together pretty well. The sales teams are largely complementary and the product lines fit together well. There's no arguing that Dell-EMC will have a full stack for enterprises to buy. The only gap would be networking, but VMware's software defined efforts may change that equation.

EMC's VCE converged infrastructure still includes Cisco as a partner. Cisco will remain a partner going forward.

Tucci said on a conference call that the merger is "historic." Whether Tucci's take is correct depends on how the combined companies address the following questions:

  • How will EMC and Dell compete with hyperscale cloud providers? EMC and Dell will be able to sell all the cloud building blocks an enterprise wants to buy. But it's not clear whether enterprises will want to build their infrastructure. EMC and Dell need to compete with the likes of Amazon, Google and Microsoft. Credit Suisse estimates that every dollar that goes to Amazon Web Services is $4 lost to traditional IT vendors.
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  • Does the narrative become easier? EMC's big problem was that its federation approach was confusing and it wasn't clear whether units could truly operate as one. With VMware independent, Pivotal operating as is and EMC continuing to be based in Massachusetts the EMC federation just looks like it's renamed under the Dell banner.

  • Product roadmaps match, but will sales teams? Enterprise customers are likely to deal with both Dell and EMC reps and account managers. How those accounts come together will be critical. Executives noted $1 billion in revenue synergies are possible.

  • Will VMware be seen as independent? VMware will become a tracking stock of the combined Dell-EMC, but the ecosystem could rumble. EMC's ownership of VMware wasn't as worrisome to the likes of Cisco, HP and Lenovo since the company's specialty was storage not servers. Dell is a major server player and competitive with VMware partners.

  • Will this deal actually happen? There's a 60-day go shop provision for EMC. In other words, EMC has two months to find a better deal beyond Dell. Cisco could swoop in as a buyer. The list of companies that could pull off an acquisition this large is short. But the uncertainty is an overhang.