What a bad idea for Microsoft shareholders.
From what I can tell, these are the possible motivating factors to invest up to $3 billion in Dell:
Microsoft Needs Dell: This is the obvious reason. Corporate bedfellows often invest in each other to protect operations. Consider when General Motors (NYSE:GM) took a stake in troubled parts maker Delphi (NYSE:DLPH), for instance. Or even consider when Microsoft invested in a very different and unprofitable Apple (NASDAQ:AAPL) way back in 1997 to give its software a wider distribution and end a patent dispute.
Hardware Hopes: Microsoft is trying to move past software. Whether you look at Steve Ballmer’s shareholder letter in October or the rollout of Windows Phones and Surface, it’s increasingly clear that the company cares about gadgets more and more. A partnership with Dell makes sense there, too, for its hardware chops to supplement in-house software operations.
Microsoft Has Untapped Resources: There’s some $66.6 billion in cash and short-term investments sitting around at Microsoft by last quarter’s tally. Sure, $50 billion or so is overseas … but MSFT has plenty of dry powder, and many investors are calling for the company to use it.
Enterprise Edge: Microsoft has fallen out of favor with consumers, but businesses still spend big on MSFT products. Dell is in a similar situation with a big enterprise push in recent years — especially considering acquisitions including Perot Systems in 2009 and more recently Quest Software last year — and a partnership could be mutually beneficial.
Those are all decent reasons for Microsoft to throw down a few billion dollars on Dell.
But here are the real-world concerns that should give investors pause:
Doesn’t Change PC Decline: Simply put, Dell might gain market share and revenue, but Windows cannot. Consider that Dell PC sales lagged — again — in Q4. According to IDC, Hewlett-Packard (NYSE:HPQ) claimed the No. 1 spot in the fourth quarter of 2012 with 15 million units shipped, Lenovo was second at 14.1 million and Dell was a distant third with 9.4 million. Dell surely could benefit from ascending to the top spot; 5 million units is a big deal. But PC sales dropped 6.4% overall on the quarter and might continue to fall going forward. So regardless of whether Dell gets a bigger piece of the Windows pie, that pie continues to shrink, and Dell’s growth will come at the cost of other Windows providers.
Hardware Hedging: Microsoft has bet the farm on Windows Phone and Surface — and initial reports seem tepid at best. Ballmer called the Surface response “modest” after launch, the Windows Phone app ecosystem is painfully challenged and it’s hard to imagine either product as a lethal threat to iPads or Samsung (PINK:SSNLF) smartphones. And if Microsoft is after Dell for hardware expertise, that’s perhaps the most damning sign of all for these mobile efforts. Who is to say that Dell could help figure out a hit, anyway? Success isn’t guaranteed by simply hammering together a hybrid tablet-laptop or a phablet. If it was that simple, the HP acquisition of Palm at the height of the mobile boom would have paid big dividends; instead, it was just a big writedown.
Another Charity Case: Let’s not forget that Microsoft has a long list of dependents it has bailed out invested in. Last April, it threw $605 million at the e-book biz of Barnes & Noble (NYSE:BKS) to provide content for its Windows mobile devices. And in 2011, it provided “billions” to Nokia (NYSE:NOK) via marketing, development support and other gimmes as a way to further its Windows Phone operating system. It does not inspire confidence that Microsoft has to rely on other also-rans in tech for its hardware and software. The Dell rumor is a sign that MSFT is content with continuing down this road.
Dell Is Not Apple: Of course, there is the possibility of breakout success here. Some remember when Microsoft bought into Apple in 1997 and point to the potential of investments like this to deliver big returns. But aside from Microsoft being the investor in both cases, there’s little analogous here. Sure, Silver Lake Partners has a good investment track record and could unlock some value at Dell. But Microsoft’s Apple windfall was one in a million based on creativity and innovation decades down the road. Also of note: Apple founding father Steve Jobs had just returned to the company to help right the ship — meanwhile, many shareholders think Michael Dell should be kicked to the curb the second a buyout goes through.
Microsoft Shareholders Get Nothing Tangible: Microsoft investors in 2013 demand action that will affect the stock in 2013 — not years down the road. Shares are roughly flat since 2003, and some fear MSFT will be dead money for years to come. While the dividend has doubled since 2008, an annualized dividend of 92 cents is a payout ratio of just 30% based on EPS forecasts of $3.02 in fiscal 2013; that has prompted calls for a big hike in the dividend or even a special payday. However, with the general sentiment that Microsoft is stuck in neutral (or worse), MSFT has decided to spend billions on a long-term boondoggle that will be spun with the typical press release full of teamwork and rainbows, but nothing that will signal better times in 2013 or even 2014. Hardly inspires confidence.
Don’t get me wrong, the Dell deal is huge for DELL traders — and if Microsoft’s muscle is what puts this buyout past the finish line, then that’s great for the people who bought in at single digits.
But Microsoft shareholders have little to look forward to. If the deal goes through, it’s highly unlikely that the current short- and medium-term challenges for Microsoft will change at all.
And if it the deal doesn’t go through? Well … it’s highly unlikely that the current short- and medium-term challenges for Microsoft will change at all.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he held a long position in AAPL.