On the surface, bidding $2 billion for a company that hasn’t made an operating profit in the last five years looks nuts.
Dig deeper, though, and the battle between Dell (DELL) and Hewlett Packard (HPQ) to buy data storage company 3Par (PAR) doesn’t look nuts. It’s looks insane. Sales are projected to hit all of $235 million for the year that ends in March 2011. Earnings before interest, taxes, depreciation, and amortization (EBITDA) are projected at just $21 million.
On August 28 Hewlett Packard bid $2 billion for 3Par, topping Dell’s previous bid, which topped Hewlett Packard’s previous bid, which topped Dell’s bid. Dell proposed paying $1.5 billion for 3Par. The latest bids come to roughly 95 times EBITDA for 3Par.
Aren’t these companies certifiable?
Well, if you’re even asking that question you don’t understand where we are in the economic cycle and how that’s driving company strategy in the technology sector.
This isn’t an age for valuation when companies carefully figure out how to get the best value for the cash they’re about to spend.
This is the era of Cash as Bludgeon. Cash rich companies are looking to club their poorer competitors over the head with dollars. At worst, the result of this spending will be a competitor unable to climb off the canvas for years. At best, this spending might be able to crush a competitor forever.
Put the Dell/Hewlett Packard contest over 3Par into competitive context and it starts to make sense, in spite of the insane valuation awarded to 3Par.
Once upon a time Dell was top dog among PC makers. And then Hewlett Packard began an aggressive strategy of acquisitions that moved the company not just into the top position among PC makers but built new strengths for the company in services, in storage, and in smart phones (Hewlett Packard hopes.)
By the time Del woke up to the changes in its marketplace it was left playing catch up.
Nothing sums up that competitive deficit better than Dell’s response to Hewlett Packard’s purchase of EDS, the giant information technology services provider, in May 2008 for a tad less than $14 billion. That purchase vaulted Hewlett Packard to No. 2 behind IBM in the information technology services market.
By the time Dell was ready to catch up in September 2009, the best acquisition it could come up with was a much smaller Perot Systems for about $4 billion.
The shift in relative market power during the last five years has been stunning.
Hewlett Packard has always been larger in revenue than Dell but the gap has widened. In 2005 Dell had 56% of Hewlett Packard’s revenue. In 2006 Dell’s revenue was up to 61% of Hewlett Packard’s revenue And then the slippage: to 54% in 2007, to 51% in 2008, and then a slight recovery to 53% in 2009.
No one who understands that power of technology companies to turn slight changes in revenue into huge moves in earnings will be surprised to discover that Dell’s relatively small slippage in the size of its revenue relative to Hewlett Packard’s resulted in a massive move in relative earnings between the two companies.
In 2005 Dell, on its much smaller revenue (just 56% of Hewlett Packard’s) recorded operating earnings 120% of those of Hewlett Packard. 2006 saw a huge plunge: operating earnings at Dell were just 65% of those at Hewlett Packard. And in 2007 the drop got worse—Dell’s operating earnings were just 36% of those at Hewlett Packard—and stayed there at 32% of Hewlett Packard operating earnings in both 2008 and 2009.
The 3Par bid is an attempt on Dell’s part to break this pattern with a disruptive acquisition. Owning 3Par, Dell would be able to sell its own storage systems rather than reselling those made by EMC (EMC). And that would give Dell an entry into the market for storage systems built around cloud computing technologies. (And Dell almost certainly thought that it had the turmoil involved in the August 6 departure of Hewlett Packard CEO Mark Hurd to its advantage. Maybe Hewlett Packard might be distracted. Turns out, maybe not.)
And Hewlett Packard is determined not to give Dell any chance at a turnaround in the companies’ relative fortunes. With $15 billion in cash at the end of the July quarter Hewlett Packard has plenty of cash to use to bury Dell. $2 billion? Pshaw! That’s roughly 13% of cash in the bank.
Of course, Dell isn’t exactly without resources itself. The company finished the June quarter with $12 billion in cash.
Hewlett Packard’s latest bid comes out to $30 a share. That’s about three times what 3Par was selling for before all this started. No reason it can’t go higher.
And if anybody at either Dell or Hewlett Packard starts to think this isn’t a good long-term use of their company’s cash, all they have to do is look across the technology sector to Intel (INTC.)
By relentlessly reinvesting its cash in new chip-making technologies and new chip factories Intel has relegated competitor Advanced Micro Devices (AMD) to near permanent second-class status. For 2009 AMD made a gross profit margin of 44%; Intel’s gross margin was 63% that year and in 2010 it has climbed even higher.
How do you catch up when you’re biggest and bigger competitor is making 20 percentage points more in profit margin than you are?
You don’t.
By the way Hewlett Packard’s gross margin lead over Dell is significant—23% to 17%–but it’s not in Intel’s class. You don’t think the folks in Palo Alto look down the valley to Intel’s headquarters in Santa Clara and dream?
In the era of Cash as Bludgeon what does a company like Intel do? Intel finished the June quarter with $18 billion in cash on hand. No way that crushing Advanced Micro Devices further would yield a reasonable payoff on invested capital.
So Intel is doing what similarly cash-rich companies (Cisco Systems (CSCO) for example with $39 billion in cash) that have crushed their competition are doing: they’re bludgeoning their way into new markets.
In Intel’s case its cell phones.
On August 26 Bloomberg reported that Intel was close to a deal to buy the wireless business of chipmaker Infineon Technologies (IFNNY.PK). Projected price about $2 billion
Intel’s chips may be everywhere in the PC and server markets, but the company is a bit player in cell phones to competitors built around designs by such as companies as ARM Holdings (ARMH.)
Buying Infineon’s cell phone unit would make Intel an immediate player. The business makes processors used in Apple’s (AAPL) iPhone and in Samsung Electronics Galaxy S phone. Intel has recently signed an agreement with Nokia (NOK) and LG Electronics aimed at eventually getting its Atom chips into phones from those companies The $430 million in revenue that the Infineon business made in the June third quarter of its fiscal year would open a lot of doors for Intel.
And the company seems determined to use its cash to make it impossible for cell phone makers not to flock to its door. On August 19 Intel announced that it would buy security software maker McAfee for $7.7 billion. The theory among analysts is that the deal would give Intel the ability to bundle enhanced security with its processors. That doesn’t seem like a high-demand item among cell phone buyers or makers right now but Intel’s strategy with its PC chips has been to add enough built in functions to differentiate its chips. I wouldn’t be surprised to see the company follow the same strategy in the cell phone market.
And to spend the cash to make it happen. Somewhere down the road.
You’ve got to say this for Intel and Hewlett Packard and Dell: they aren’t sitting around planning strategies for the next quarter or two.
Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio. Cisco Systems and Intel are members of my Jubak’s Picks portfolio.
ryan,
So you’re saying that insider ownership for a company the size of INTC is just as meaningful as it is for a much smaller company the size of TC? And saying both are “large companies”, when Intel is over 100 times as large? Feel free to explain why? Frankly, the numbers don’t back up your accusations.
If you’re going to prove me wrong, then PROVE ME WRONG. Just saying I’m wrong doesn’t prove anything.
As for analysts, no, I don’t pay attention to them. I merely pointed out the recommendations getting downgraded, as the rats scurry off the sinking ship that is the Potash buyout.
I never said Potash wasn’t worth more. What I said was the original BHP offer was the best deal that Potash (or their shareholders) will get NOW, unless the whole thing falls through and they wait a few years for the companies value to catch up to the offers on the table.
One of the inherent problems with the Potash CEO’s evaluation of his company is that he is looking at the POTENTIAL value, with growth included, down the road a few years. While I don’t disagree with his evaluation, the shareholders have to be more objective. A lot could happen between now and then. Do you take the money now, or wait a few years and hope that the economy doesn’t totally mess up any chances for Potash to reach the rosy evaluation that the CEO has?
We’ll see what happens with Potash. I’ve made my prediction, and you made yours. If I’m wrong, I will happily come on here and admit it. Will you?
Ed McGon….Im so sorry I just came back to say hi, lol. Actually I came back because I saw people still asking you for advice so it became clear that my work here is not yet done!
I have pointed out why that is in previous posts. Further proof…..what in the world are you talking about in that post about TXN vs INTC insiders? They are both large companies…you are backin and fillin like crazy trying to pretend your point has any consistency.
Your comments about Potash are a statement of the obvious surrounded by comments so naive I can hardly stop laughing. Do you really pay attention to analysts Ed? The ones who called the bank meltdown after it happened and usually downgrade stocks just as they hit bottom or upgrade them just as they are peaking?Those analysts Ed? And the price hasn’t moved squat in a whole two weeks? Are you serious?
Lot’s of things can happen in a deal Ed and if you can’t stand the excitement, stand on the sidelines and blog about it. If you actually know anything about the subject that is. I reiterate my point that smart/lucky people who own POT should take some profits and those who can risk it should hang on for a better deal with part of their position or perhaps buy an option or two. I wonder who knows the value of the company better..EdMcGon or the CEO of Potash? Tough call.
Now, this morning, Ed, I suggest you go to Burger King and enjoy a whopper!! I apologize for underestimating the buyout price yesterday. I don’t expect a fight over this one since djpoints is right about McD’s However, we are buying stock here and BKC was the better stock recently. Oh but wait, Ed….what did the analysts say about BKC last week? Any downgrades?
Enjoy the profits guys and don’t listen to serially posted nonsense from pseudo experts. You know who I mean. I hope.
ryan –
wow, check out BKC! please post more suggestions, i wish i’d followed this one. way to go!
ryanpatrik,
One last thing. Your prediction was, “Anyway, the Potash story is far from over and the final price will probably be closer to $200 than $130. Hold on to a few shares at least so you can enjoy the ride since this kind of bonus comes along rarely enough.” You wrote that on August 18th. Since then, POT has done…squat.
In addition, there have been at least 2 downgrades by analysts since you said that. Maybe they can read the writing on the wall?
Mind you, I am not suggesting that I am right and you are wrong. I am saying there is a STRONG possibility that you are wrong, and suggesting people hold onto POT right now is speculative advice, at best.
I’ll give you my prediction: This deal will happen a lot closer to $130 than $200, if it happens at all. If it doesn’t happen, POT will be back around $110, or lower. I just hope you can remember that…
ed
that makes some sense, thanks
ryanpatrick,
I never said that about Intel, but I seem to recall you saying you were done with Jubak’s website. Maybe your memory isn’t as good as you thought it was? 😉
semievolved,
Size is the difference. TC has 700 employees, whereas Intel has 80,000 employees. TC has a $1 billion market cap, whereas Intel has a $93 billion market cap.
The smaller the company is, the more I like to see them have some skin in the game. Mind you, it is not the only factor, but it does make a company more attractive.
question for Ed
I also like INTC but I notice there is only 0.3% insider ownership. A little while back you trashed TC and one of your main reasons was low insider ownership. TC has 0.4% which is slightly more than INTC’s. Why is lack of insider ownership important on TC and not on INTC?
Southof8…excellent point as always. Still holding potash? A rival bid is coming. I woke up this morning to another bit of news that djpoints will want to know….buyout talk around Burger King. I suggested moving out of MCD into BKC last week, not because I knew something was brewing but because the stock was a screaming bargain in an industry that does fine in bad times and good. We are in a buyout era similar to the eighties so any bargain stock can easily be a buyout. In the eighties it was junk bonds. Today it is junk currency and zero interest rates but the buyout frenzy is only beginning.
Burger King is still a buy if you can get it under 18. If a buyout happens it will be around $21-22 and if it doesn’t you can hold the stock and do just fine. Other candidates…regional banks trading at or under book value (FITB, HBAN, CRBC, MI BPOP) and other Canadian resource plays like CNQ. Send a commission check to a favorite charity!! lol
Oh..and I can’t forget you EdMcGon since you have once again completely changed your tune. Was it not right here a week or two ago that you said you wouldn’t buy Intel because someone might come along and make their product obsolete? Now you are holding it through corrections for the dividend? Which is it? And should we still make sure we get out of the market by December now that it is down almost 10% from it’s recent peak? Let us know so I can do the opposite! hehe..I kid you Ed but really, some of us have memories that last more than 24 hours and I say this in kindhearted way.
thetick83,
That was EXACTLY the same reasoning I used for buying Intel.
If you’re willing to sit on it for a very long time, is there any difference between 1779 and 1767?
Wait a few days and you’ll have a chance to buy it at 1755 so your average cost is 1767.
I bought some Intel today at 17.79, wish i would have gotten in at 17.67. At 3.5% yield, I am willing to sit on it for a very long time.
Ed,
could you email me at rip024@yahoo.com
I have some questions about how you find buy and sell point and also feel ok about holding stocks through scary times (like now)
creativekev, may seem expensive for Intel but if they can offer security with there chips I may pay there $20 more. Last 3 PC I built I used Amd. Other wise I’ll keep using Amd chips zone alarm and trend micro on my windows PC’s
Why Intel is buying Infineon: http://www.fastcompany.com/1685812/why-is-intel-buying-infineon
Jim… thanks for the INTC discussion. I’ve been holding it for awhile and agree with Ed, I’ll keep holding in a correction and even look at adding if the price is right. I wondered about the McAfee purchase, but their track record for adding value is tremendous.
I understand the essential role of security, but Intel paying $7.7 billion for McAfee seems too expensive. Time will tell if this was a good use of their (and their shareholders’) money. On the other hand, spending $1.4 billion for Infineon’s wireless chip division seems very reasonable considering Infineon’s chips are inside the Apple iPhone. With iPhone usage still expanding worldwide and Infineon chips potentially in iPads too, that is an acquisition with strong upside for Intel.
I was wondering why they are bidding with such irrational valuations. Is there no other company like 3par for Dell to grab? This reminds me of when Google and Apple were fighting over mobile advertising acquisitions.
Algalli,
No one likes to be 2nd fiddle! HP has Dell firmly in the 2nd fiddle position. Now, if HP is able, they will hand Dell a bloomin’ viola (no offense to viola players)…”3rd fiddle”! Don’t think for a moment HP will sit on the no. 1 position! They seek to destroy Dell.
I read an article somewhere that HP’s customer service was better than Dell’s according to some consumer rating service. Not that it has anything to do with this article…personally, I hope HP sends Dell to the shower (past the bloomin percussion section…sorry drummers…and out the stage door! Boy am I in a foul mood on this one! I do like the fiber optic photo, Jim! Great job!
Hp should simply walk away at this point. Dell will be further crippled with this cost and HP can certainly hire plenty of good people to build the equivalent business from the ground up. If they persist in buying this company it is time to sell HP because they will have shown no regard for the shareholders money.
I must admit, Intel is one of the few stocks I hold for which I am willing to ride out any major market corrections. I’ll happily take the 3+% dividend until it turns around.