Dell Inc. (DELL) agreed to pay a 68 percent premium for Perot Systems Corp. (PER) in a $3.9 billion acquisition announced today. That's a shockingly high figure in a stock market that has run up enormously. What's more, Dell paid cash, $30 per share, a step that means all the risk in the deal is held by Dell.
Perot Systems is hardly a paragon of growth: in the last quarter, it only netted $31 million on $628 million in revenue. According to 24/7 Wall Street, Dell wildly overpaid for Perot, and shareholders should be outraged. But CEO-founder Michael Dell may not have had much choice, due to the dearth of potential targets for acquisition in this arena, and the dimming profitability prospects in the consumer and small-business markets for servers and computers.
In other words, Dell has run into a simple immutable fact. Efficiency gains in its primary PC and service business have grown so hard to obtain, and pricing in that segment has become so tight and onerous, that any company basing its future on selling commodity boxes will not have a bright future. Time for Plan B, which means buy your way to profitability.
The top ranks of the IT consulting and services business are now consolidated into two areas. Oracle Corp (ORCL), International Business Machines (IBM), and Hewlett-Packard Co. (HPQ) have deep product expertise, including their own enterprise product lines in software and hardware, and a reputation for being to handle the most complicated installations including big-ticket ERP systems from the likes of SAP AG (SAP).
The second category is the Indian outsourcing shops, like WiPro LTD (WIT), which have grown into roles as providers of big-ticket computer services as well. A handful of other players, including Computer Sciences Corp. (CSC), are very tightly interwoven into U.S. Department of Defense research contracts, and are therefore a harder acquisition.
One of the only other orphans in the computer-services business of any significant size was Accenture LTD (ACN). But Accenture management has struggled to bring the company back onto growth track. Its business is more focused on selling large-ticket software and did not have the deep bench of data center and mainframe expertise that Perot holds.
Keep in mind, mainframe expertise is actually quite valuable to Dell, particularly in the health-care arena, where many of the large insurance players are still tied to mainframes. Dell is selling its own line of high-performance computing clusters which compete with mainframes. But Dell also needs to offer a credible service offering for customers who prefer mainframes and don't want to go to a configuration based on clusters of servers instead.
For its part, Perot has struggled to grow as the IT consulting business has consolidated around larger players such as IBM, HP, Infosys, and WiPro. It has exhibited some troubling signs of late. Dell is acquiring Perot in part because it hopes it can leverage Dell's broader presence to diversify Perot out of the health-care and government sectors, where most of its revenues reside, according to ZD Net. But in the last quarter, revenues from Perot's health-care business actually declined by 8 percent. Health-care is one of the only areas that has successfully resisted the downward tug of the recession, so any signs of sales erosion in this core market are not good.
So how could Perot have squeezed such a huge premium out of Dell? For Dell, which has long partnered with Perot, the deal is highly convenient from an integration standpoint. The two companies are both located in Texas, and only 200 miles apart. But the reality is, Perot had what Dell thought it needed to grow, and the 68 percent premium reflects that.
Alex Salkever is a senior writer at AOL Daily Finance covering technology and cleantech. Follow him on Twitter at @alexsalkever.com. Email him at email@example.com.
Understanding Stock Market Indexes
What does it mean when people say "the market is up 2%"?View Course »