Wednesday, August 18, 2010

Late to the Enterprise Services Market, Dell Agrees to Buy 3PAR at an Extremely High Premium; Could A Competitor Counter-Bid?

On August 16th, Dell announced it signed an agreement to acquire 3PAR, a provider of highly-virtualized storage solutions, in a transaction valued at $1.15bn. The offer was an 86% premium to Friday’s market close. Under the terms of the agreement, Dell will commence a tender offer to acquire all of the outstanding common stock of 3PAR for $18 per share in cash. The acquisition is expected to close by the end of the calendar year and retention agreements are in place for 3PAR management. The company has revenues of $200 million (only 20% of sales outside the US) with gross margins of about 65% and operating margins in its latest quarter of 2.4%.

The 3PAR acquisition marks the largest storage acquisition for Dell since the company bought EqualLogic for $1.4 billion (closed January 2008); other recent storage acquisitions include Ocarina Networks, Scalent, KACE, Exanet, and The Networked Storage Company. The acquisition will extend the Round Rock, Texas-based computer manufacturer’s storage offering. Dell was late to expand into enterprise services and has been buying companies to build out Dell Services. They recently bought Perot Systems following HP’s purchasing of EDS.

As highlighted at its recent Analyst Day in late June, Dell continues to focus on enterprise segments for future growth and margin expansion, via organic and inorganic means so the 3PAR move is not a big surprise. Even after the 3PAR deal is done, Dell might be looking to make at least one larger acquisition in software and a few smaller ones given its need to stimulate revenue growth and fill large gaps in the enterprise quickly.

With the 3PAR acquisition, Dell services meaningfully broadens its storage portfolio and provides an entry into the high-end SAN market with a Dell-owned product offering (vs. reselling EMC Symmetrix), fits well with Dells focus on scalable cloud-based solutions, and should drive revenue synergies from driving 3PAR product (and associated services attach) through Dells channel and customer relationships. According to outsourcing advisory TPI, companies are actively exploring cloud-based solutions and are ready to talk to cloud service providers. Of the 27 cloud solution areas clients TPI was testing, they were most interested in storage services as one of top 3 categories.

We expect this transaction to strain DELL’s reseller relationship with EMC. While the direct impact to EMC is likely small in the near-term (2-3% of EMC revenue), Dell is clearly executing a strategy to build-out a complete storage product family and reduce its dependence on EMC over time. The 3PAR product line directly competes with EMC’s Symmetrix product family, and gives Dell a strong technology in the high-end storage market.

Dell is paying roughly 6x sales, which is well above the current average of 2-3x for storage companies, suggesting the process was competitive. While we admit that the deal looks expensive, the price tag will ultimately be judged by how successful they are in generating revenue synergies following integration.

Despite a hefty premium Dell had to pay, we would not rule out a rival offer considering the bidding war over Data Domain just over a year ago. Data Domain entered an agreement to be acquired by NetApp only to be topped by storage giant EMC. In my opinion, a rival bid is always a possibility in any deal until it is closed. However, since Dell paid a rich price and it would be very difficult for a rival top the $1.15 billion offer. Other logical buyers include Hewlett-Packard, Oracle and NetApp. Since HP has just let go of its top dealmaker CEO, they may not participate. There is a clear strategic rationale behind each “white knight” while EMC too may decide to counter-bid.

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