Dell's Perot Bid A $3.9 Billion Gamble

Dell (Dell)'s proposed $3.9 billion buyout of Perot Systems could be a boon for enterprises looking to implement new wave architectures like virtualization and cloud computing. But those benefits will only be realized if Dell can manage thorny integration challenges bound to arise as it looks to absorb an organization known for its rigid, by-the-book culture and reliance on a market—healthcare—where the PC manufacturer has little experience.

Adding to the uncertainty is Dell's status as a neophyte when it comes to both IT services and M&As. Not that there isn't a solid plan in place. Dell wants to marry its hardware and automation software with Perot's integration and outsourcing services so it can offer business customers end-to-end computing solutions, mirroring earlier moves by rivals HP  and IBM. The piece parts are all there, in theory at least.

Dell has the iron and applications needed to form the bedrock of advanced data center setups. The company, for instance, has partnered with VMware to bundle the latter's View offering with its Latitude and Optiplex client machines and PowerEdge servers to create an off-the-shelf virtualization package. It's also tweaked a line of servers to deliver optimum performance on Microsoft's cloud-based Azure operating system.

Perot, meanwhile, brings expertise around integration, deployment, and systems management. Just weeks ago the company launched a cloud integration service under which it advises customers on various hosted offerings, combines cloud-based products from different vendors, vets them for security issues, and--if the customer chooses--hosts and manages it all from one of its massive data centers.

Michael Dell thinks it's a winning hand. "The result will be the combination of two iconic IT brands who share a common vision of reducing IT complexity and total cost of ownership for our customers around the globe," Dell said at a press conference Monday. "This acquisition makes great sense because of the obvious ways our businesses complement each other and enables us to grow profitably over time," Dell said.It sounds good on paper, but does Dell have the management chops to create a situation where, in the words of outsourcing advisor Steve Martin, "one plus one equals three?

"Perot is very methodical and somewhat stiff and regimented", said Martin, a Deloitte veteran who is now a partner at Pace Harmon consultants. "That's not the culture that Dell has had. These are two very different kinds of companies so the integration issues are not going to be trivial," said Martin.

In its favor, Dell deepened its bench strength earlier this year—luring away IBM's top M&A guru, David Johnson. Johnson's experience could be crucial to Dell's ability to add Perot's operations without alienating customers or employees. Dell's only major buyout to date is its $1.4 billion takeover of storage specialist EqualLogic. At IBM, Johnson oversaw 14 significant acquisitions in 2008 alone.

But even there there's a hitch, as Johnson's participation isn't assured. IBM sued the exec earlier this year for breach of contract after he leapt to Dell and has asked a judge to force Johnson to honor a non-compete contract. The case is ongoing.

Integration risks aside, many observers believe Dell has little choice but to diversify. The recession, commoditization, and competition from a renewed HP  have taken a harsh toll on the company's top and bottom lines. Dell's PC sales slumped 33% in the most recent quarter, while sales of servers and storage products were off 22% and 19%, respectively. And the company's reliance on hardware for the vast majority of revenues has saddled it with an anemic operating margin that's currently in the 5% range.JP Morgan analyst Mark Moskowitz called the Perot deal "a good first step" in Dell's campaign to lessen its dependence on boxes.

Perot has weathered the recession fairly well, but if Dell is to seriously challenge IBM and HP-EDS in outsourcing, it will have to take a company founded in 1988 by billionaire and gadfly politician H. Ross Perot well beyond its base in the healthcare market. Perot Systems derives half its revenues from healthcare, 25% from the commercial market, and 25% from the government sector.

"We believe Dell will need to expand the services capabilities of Perot Systems to other verticals to establish a major enterprise services platform," said Moskowitz, in a research note.

Dell says it plans to do just that, calling its agreement to acquire Perot an "anchor" for other moves. "This [deal] will bring Perot Systems capabilities to a much wider set of customers" said Michael Dell, who envisions parlaying his company's strength in numerous commercial segments into new accounts for Perot, which is on pace for $2.5 billion in sales in the current fiscal year.

In the meantime, customers of both companies will need to keep a close eye on the merger's progress. For hardware buyers, there's the potential to fall victim to upselling as Dell will no doubt aggressively push service offerings onto to its existing client base after the deal's complete. And Perot customers need to guard against tempting bundling deals that look good up front but can hide the true cost of what they're paying for hardware."When there's a bundled procurement, the vendors have an amazing ability to show you what they want to show you and hold back what they don't want you to see," said Pace Harmon's Martin. "If the equipment provider and service provider are the same and that's the best deal, then you contract together. But otherwise you want to look separately," Martin added.

Martin suggests Perot customers—or prospective customers—obtain certain guarantees before committing to new contracts while the outsourcer is in transition. Among other things, Martin advises getting written assurance that a particularly effective account rep or service delivery manager isn't shunted off to "a hot Dell account."

Dell hopes to close the deal later this year or in early 2010. To get it done, it will buy up Perot's outstanding Class A shares for $30 per share—a significant premium over Friday's $17.91 closing price. Current Perot Systems CEO Peter Altabef is expected to continue leading the operation. Plans also call for Perot chairman Ross Perot Jr. to join Dell's board. Dell said it believes the acquisition will contribute positively to earnings by 2012.