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Will Dell's Perot Splurge Be Worth It?

Jeremy Glaser

Jeremy Glaser: I'm Jeremy Glaser with Morningstar. The M&A wave continued this morning as Dell announced its intention to purchase Perot Systems for around $3.9 billion. Here to discuss the acquisition with me is Dell analyst Rick Hanna.

Rick Hanna: Hi, Jeremy.

Glaser: So, Rick, do you think that this fundamentally changes the story of Dell?

Hanna: No. What it does is it expands their services footprint. For some time they have been wanting to build out their services business [which has] a higher proportion of recurring revenue ... hardware tends to be more discretionary, so in this economic climate that falls.

So they kind of want to go into that push and emulate some of what HP and IBM have been doing in terms of expanding into services, but do it kind of with a unique twist, offer more modular services, not the wholesale run-your-data-center type. And so I think that Perot helps them in that regard, but it doesn't necessarily change the underlying competitive dynamics; it's just too small.

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Glaser: So this isn't going to catapult them into the same services league as HP or IBM?

Hanna: I don't think it's even in the same league. The combined entity will be $8 billion on a run rate basis. That compares with HP-EDS at $34 billion and IBM at $55 billion. So those two companies have a much wider reach both in terms of industries covered as well as a global reach.

Perot Systems also was very focused more on the health-care IT and government services. Those are attractive niches in and of themselves, but they're not the expansive, "I'm going to be everything to everybody" sort of services approach.

Glaser: So, Perot Systems is up 65% today, Dell is certainly paying a pretty hefty premium at the last closing price. Do you think the valuation is fair?

Hanna: We think it is a bit rich, not only from the fair value that we had of Perot Systems, but just in terms of looking at standard multiples. I looked at what HP had acquired EDS for and Dell is paying quite a bit more for that.

I think it speaks to Dell needing to make this acquisition in terms of being able to expand its services portfolio, and it was the one that was within their reach. There are some other services companies out there, but they are probably beyond what Dell can afford?

Glaser: So does it impact your valuation on Dell?

Hanna: No. You know, I looked at that; on a combined basis, Perot would be less than 10%, so I am pretty comfortable with the fair value estimate at this point. But what I am concerned about is in that premium, they've got to fire on a lot of cylinders, not only in terms of being able to get costs out, but revenue synergies I think is the number one priority for them. I think it's achievable, but I don't think it's going to be a home run. It certainly won't cause me to raise the fair value estimate.

Glaser: So do you think Dell is attractively priced for investors right now?

Hanna: Right now we have it fairly valued. It's trading at around $15 and change, somewhere around there, and our fair value estimate is $17.

Glaser: Great. Thanks for talking with me today.

Hanna: Thank you, Jeremy.

Glaser: For, I'm Jeremy Glaser.