Peak Desperation

When Standard and Poor’s downgraded Dell to junk in September 2013, it cited the slump in the PC business, the pricing pressures in the sector, and the proposed buyout of the company by founder Michael Dell and private equity firm Silver Lake Management. They’d heap new debt on the company whose sales at the time had dropped 8% from a year earlier, and whose net profit had plunged 32%. But at least it still had a profit.

Today the PC industry is still in trouble. HP has been laying off people in big mega-waves, so have Microsoft, Intel, and others.

But OK, instead of investing in cutting-edge products and services that could move the company forward, it’s the perfect time for Dell and its investors to embark on the largest tech deal ever, a masterpiece of financial engineering, the $67 billion buyout of data-storage company EMC.

Standard and Poor’s, which affirmed Dell’s current junk rating of BB+ but put EMC on CreditWatch negative, figured that the deal would be funded through a mix of debt issuance, including perhaps $40 billion in leveraged loans, equity from current owners and the Singaporean wealth fund Temasek, some cash on hand, and the issuance of a flimsy tracking stock – similar to issuing old bicycles – to track VMware’s stock price. Details have not been disclosed.

Wall Street loves it. A whole slew of financial advisors are in on the deal, on both sides. The $40 billion in leveraged loans alone could rake in $500 million in fees, Business Insider reported. Total advisory and financing fees could exceed $700 million. Ka-ching.

And what multiple is Dell paying for EMC? Back in 2013, Michael Dell and his compadres were paying 5 times Ebitda (earnings before interest, taxes, depreciation, and amortization) for Dell. Now, to show the world just how crazy the M&A boom has gotten, and how valuations have soared, they’re paying 12 times Ebitda, according to Bloomberg’s math. At this valuation, things would get dicey even in a hot, high-growth industry for a healthy, growing, and profitable acquirer.

But Dell is none of these.

As a privately-owned company, Dell doesn’t publish financials via SEC filings. The holders of its debt securities receive quarterly reports that Dell doesn’t have to disclose. But the New York Times obtained the confidential report for Dell’s fiscal second quarter, ended July 31, 2015. And it was a doozie.

For the six months ended July 31, revenues dropped 7% from the same period last year to $27.5 billion. Gross margin dropped to 17.1%, down from 18% a year earlier. And its net loss jumped 35% to $768 million.

The Times:

And in discussing the gross margin, Dell’s filing pointed to some of the struggles it is facing in the division that focuses on selling computers. It said that the margin shrinkage was “primarily driven by an overall market decline resulting in a decrease in desktop and notebook units sold, in conjunction with challenging pricing dynamics.”

Gross profit for that segment for the six months through July plunged 26% year-over year to $2.5 billion.

Cash flow, the single most important measure to see if the company can service its debts, plunged 37% to $733 million. But even that dwindling cash flow appears to be of dubious quality. The Times:

And in the latest period, Dell appears to have squeezed more cash out of sources than it might be able to repeat, such as by pressing its customers to pay more quickly. Cash flows also benefited from a large positive change in a line called “other assets.”

Alas, even as sales, profit margins, and cash flows are declining, Dell’s finance unit is funding more sales: total loans outstanding to its customers rose nearly 3% year-over-year to $5.17 billion. A sign that its customers are running out of money or falling behind? Or that Dell is using financing – perhaps even subprime financing – to stimulate moribund sales? We don’t know.

We do know what HP has been going through after its big acquisitions: business disruptions, lawsuits, declining sales year after year, morale problems, failed CEOs that then run for political office, investment in financial engineering rather than actual engineering, huge write-offs and losses every few years, and wave after wave of mega-layoffs.

But no deal HP has done comes close to Dell’s acquisition of EMC. That deal, the flood of junk debt it will disgorge, and all the problems it will cause are in a class of their own. That this deal is even taken seriously shows that the Fed-designed credit bubble that Wall Street cherishes so immensely and can’t conceive living without has reached peak desperation – before it all ends.

With so much Wall Street horsepower lined up behind it, funding for the deal will likely go through. But Dell is facing turbulence and air pockets as it tries to sell its new junk debt. Read… Junk Bond Issuance Collapses as “Distress Ratio” Spikes

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  20 comments for “Peak Desperation

  1. CrazyCooter says:

    Any readers know if the declines in sales/income/growth/etc are tied to the revelations of US government (NSA, military, etc) involvement with tech companies for the purpose of spying on overseas customers/governments?

    This was in the news quite a bit a year or so ago and dire predictions where thrown around with regards to Microsoft, IBM, Cisco, etc, but I don’t recall directly seeing anything that singled out Dell.

    With that in mind, Dell is in a prime position to distribute hardware with vulnerable BIOS, which is the holy grail of hacking. Here is some introduction to the subject from a slightly different vector:

    So, the thesis is that global orders of US tech companies are going to slow down for years to come as core foreign industries, such as government, banking, etc, pull back from US technology supply and attempt to source hardware and software from more “trusted” sources or grow these industries domestically.

    I don’t have a dog in this hunt, but I would be curious to know how much is foreign customers pulling back on orders (due to trust issues) versus overall decline in orders due to a crappy economy.



    • MC says:

      Cisco Systems (of which I am a customer) was hit hard by the scandal, but only in Asia: apparently the Chinese government instructed companies they own, control or deem significant enough to cut their orders with the San Jose company. The dip (40%) was too sudden and massive to be the result of companies becoming suddenly aware of inbuilt vulnerabilities. Sales in China have never truly recovered and now, well, there are other problems there.
      What the Snowden revelations did was driving demand for encryption, firewalls and everything security related through the roof. Just last year the European operations of a major US company I won’t name spent the equivalent of US $120 million to completely overhaul their cybersecurity operations. That’s a whole lot of money.

      Truth to be told the decline of “can do no wrong” companies such as Dell can be attributed to a number of factors, all coming into play at the same time.
      First and foremost is the fact they have spent too little on innovation, both to offer new products and “more for the buck” to their customers. Very much like HP back in the days, a lot of that CAPEX seems to have gone into bloatware nobody wants or needs.
      Second is the raise of very capable smartphones and tablets, which savagely mauled the laptop market, once the breawinner for companies such as Dell, Fujitsu-Siemens and HP. I have an older smartphone (iPhone 4S) and while on the road it does everything I may conceivably need and more. I can only imagine what newer phone and especially tablet models from Apple, Samsung and other manufacturers are capable of. And if I need to carry plenty of data, a 32GB or more USB pen drive does the job well, fits in my jacket pocket, is dirt cheap and can be encrypted if need be.
      Third is, to be honest, factory-assembled computers are horrible bang for the buck these days. To build a very capable office PC these days you don’t need to be Bill Gates. If I managed to do it, everybody can. At worst the cost of components plus paying for the services of some PC-savvy youth is far less than what Dell, Asus or other manufacturers will charge you for a similarly performing machine, with the big advantage you will have only what you want and need on your hard disk(s).

      Of course demand for servers is not only still there, but growing at a frantic pace.
      I may understand Dell wanting to acquire server operations to increase their existing ones, but the EMC deal looks a whole lot like an anemic anaconda attempting to swallow a water buffalo whole.
      Also there’s the big threat looming at the horizon of MS Hyper-V. Despite being around in various iterations since 2008 or so, it’s coming of age only now. And the less we speak about cloud storage making in-house data centers redundant, the better…

  2. hoop says:

    Would be nice to know Mr. Dell his net position in his company. Yes, he have maybe shares but also maybe derivatives in opposite position. Like Mr Paulson had in subprime housing mortgages.

    The whole QE period is used to get previous bad loans and bonds to the public (people/companies) off the balance sheet of banks accept some high quality collateralize loans to maybe Coca Cola, Boeing etc. The super senior loans/bonds to the top tier of the economy. After all shit has been disposed, the market can come down and banks can start to loan money again at lower assets prices. All debt load taken on by the companies can be transferred into share capital. And this will be the moment when John Hussman and many others will be right about reverting to the mean.

    • rich black says:

      Hoop, just as Donald Trump put mega money in his own pocket, while filing four corporate bankruptcies, Micheal Dell will make bank on this deal, regardless of whether it fails to make money in the future. As for your question about a Paulson short, or even some kind of pump-n-dump, either or both are distinct possibilities.

  3. West says:

    Speaking strictly to the technology need behind this deal, and not the financials, this deal is needed by Dell to stay competitive in a game where there is no clear major player. I don’t see any technology parallels here between Dell/EMC and other boondoggles such as HP/Autonomy, or AOL/TW – the ultimate “market top” deal.

    Dell, having slowly become obsolete in the consumer segment in phones, TVs, peripherals, desktops, and now laptops and tablet computing, has become a hardware and services seller to corporate America. The one segment that Dell has remaining is the corporate data center (EMC – win) which is largely moving towards virtual services (EMC/VMWare – win) as hardware horsepower has outpaced the need for dedicated servers. This is also the same direction that HP is moving towards, with both Dell and HP trying to build a consulting services business a la IBM and sell hardware and become the sole integrator of technology for large firms. When HP completes their “breakup”, Dell will be the only vertically integrated technology provider, outside of Lenovo, which lacks the consulting and storage devices arm that Dell that will have.

    Until another company springs up that can bundle server hardware, virtualization, technical integration, and a robust devices business (tablets/phones for employees), this is about as good as it gets.

    The biggest technical threat to this deal is Microsoft hyper-V technology (replacing VMWare), big data in the cloud reducing need for costly on-site disk arrays (EMC), and the BYOD policies being implemented by many companies that will only get more common with Windows 10 and the general “security and access” improvements it envelopes.

    • Petunia says:

      The Dell brand is not associated with quality, at least not on the consumer level. I wouldn’t buy a Dell product at any price. As I recall, Dell made most of its money selling service contracts it didn’t honor, and the products had a reputation for breaking down frequently.

      The deal seems to be very overpriced. Good for the EMC shareholders, but I would bailout if I was an EMC employee.

      • randombypasser says:

        I don’t know about consumer products but around last 5 years the business PC’s from Dell have beaten competitors on overall basis in northern Europe. I would not recommend any other business PC than Dell unless forced to, until lately.
        A dream too good to be true, lately there have been more severe quality and functionality problems even excluding firmware related ones, the service personnel is much less professional than before and yet the unit prices have been raising far faster than competitors.
        As most of our customers and any companies in Finland rely on big names there is not a much to recommend anymore.
        But that’s evolution at it’s best, seen this before :)

    • randombypasser says:

      As i see it, Dell is trying to do IBM’s and get rid of most of the device producing (at least) and concentrate on software/service/cloud.

      • West says:

        Yes, I was trying not to comment on that aspect but it’s true. Except dell will retain the HW aspect. IBM is in serious trouble though, they’re trying to become the Wipro of the US, while charging legacy IBM blue suit prices. Having been in this game, it’s not going to end well for IBM as customers are fighting this tooth and nail. If something doesn’t change there, IBM will be bought for pennies on the dollar in the next recession by one of the big consulting firms, like Deloitte, SAP, etc.

  4. Vespa P200E says:

    Dude, you need Dell, NOT.

    Good points Wolf as Dell taken private largely due to declining revenue and profit (and joke share price) gets more “cheap” financing to buy the server industry leader EMC with its hardware and software offerings by issuing more junkiest bonds?

    We must indeed be near peak with this joke acquisition by weakling to swallow the stalwart via cheap junk bond proceeds before the junk bond market implodes…

  5. merlin says:

    This should be a KKR-backed deal…or at least inspired by KKR. How long til the new company goes Chapter 11?

  6. Petunia says:

    There was news of a beer merger this morning that I thought was ridiculously priced, $106B deal. Just doing the quick math, at $106B/7B = $15. Seven billion people would need to drink $15 worth of beer just to cover the cost of this deal before interest or cost of production. Or if you wanted to be more realistic, one billion people would need to drink $106 worth of beer to cover the price of the deal. I think this monster is a safe short.

  7. Julian the Apostate says:

    My iPhone 4 was still hobbling along but more and more glitches popping up, so I bit the bullet and upgraded to the 6. The other day while in the shop I used the company wifi to download iOS 9. The controls are almost identical to the old phone with some new stuff thrown in that I’ll never use, but the speed of this beast is simply amazing. We still have our 2007 Mac desktop but we never seem to use it anymore, the wife has a newer android. We skipped right over laptop and tablets (although they gave her one free with the phone) I don’t know what she uses it for if anything. I can definitely see where PCs are in trouble.

  8. ERG says:


    One of the first signs that the end is near.

  9. Peter says:

    I am a Dell man and have been so since Dell went into business. However, long ago, I went from purchasing the state-of-art to the state of the lesser art.

    I buy reconditioned Dells on Ebay – have never been cheated and receive machines in excellent quality. At the moment, I have 3 identical Dell Latitude E6530 running Windows 7. I paid no more than $650 for each machine.

    My machines are clones. So are my 3 WD remote hard drives (2 T). I re-clone my hardware religiously. I use my Samsung Note 3 for telephone calls, screening emails and messages and dictating replies orally. I read Wolf Street and ZH Jesse’s CA on the Internet and not much else. Look up stuff on Google.

    Have any of you every tried to prepare a spreadsheet on your cell phone – for me – impossible. Try reorganizing 50 years of photo archives via Picasa on your tablet (1T worth) – I can not do it.

    When I go on the road, I take my 8 pound laptop and remote drive – good weight training. I will not get stuck without my data and with underpowered equipment. If my stuff gets destroyed someplace, I have two clones in safe places standing at the ready. My total “system” does not cost $2,500. And, I have practically every software invented.

    I plan to “upgrade” when Windows 7 goes unsupported around 2021. In summary, I might be one of the reasons why no one can make much money in hardware today.

Comments are closed.