EMC Corporation (NYSE:EMC) stock surged over four percent Thursday after rumors surfaced that the company was in merger talks with Dell. EMC shareholders are rejoicing after the struggling stock picked up momentum. But what’s in it from Dell?
Dell, the giant computer technology company with multinational footing that went private two years ago after struggling in the stock market, has finally found some ground to reposition itself on in order to reclaim its lost glory. The age of the internet has shifted many offline businesses to online. Giants like Alphabet, Inc. (NASDAQ:GOOG) and Microsoft, Inc. (NASDAQ:MSFT) are virtually storing most of the world’s data today. Enterprises are now trying to streamline costs of data storage and content management by switching to either cloud computing or other cheaper and faster offline alternatives. This great market shift in recent years has created a new niche that Dell can exploit to get back in the game.
What Does This IT Merger Mean for EMC Stock?
Dell plans to raise $50.0 billion for the leveraged buyout of EMC at approximately $27.00 apiece. It’s important to note here that this deal will not only be adding the $50.0 billion to Dell’s balance sheet but also bringing in an additional $5.5 billion in long-term debt and roughly another $6.0 billion in long-term liabilities from EMC’s balance sheet. This is alarming because Dell is already busy paying down the debt it incurred when it went private two years ago.
Worse yet, of the $45.0 billion in total assets that EMC holds, over $16.0 billion is just goodwill. This absurdly overvalued intangible is virtually worthless for a privately held company like Dell. As for EMC revenues, those have grown year-over-year, but the growth rate has slowly lost pace to become relatively flat in the last four years. The EMC stock saw its best times during the dot com bubble, but has since then been struggling. The stock has oscillated within the $20.00 to $30.00 range for over a year now, currently valuing EMC at $52.0 billion.
If the deal looks so bad on paper, why is Dell still buying it?
EMC is an enterprise data solutions company that sells server, networking, and data storage products worldwide. The company is a market leader in the data storage industry, which currently stands at $24.0 billion and is expected to grow to $27.0 billion by 2018. (Source: Understanding IDC’s Flash Sales Figures, December 10, 2015.)
EMC currently earns the biggest chunk of its revenues from its high-end all flash arrays (AFAs). For EMC to be a profitable acquisition for Dell, EMC must keep pulling revenue growth out of its AFAs. The demand for all flash arrays has picked up pace in the recent years, bringing HDDs close to extinction. A common argument against AFAs is their pricing. Although the AFAs have much higher performance than the HDDs, their high pricing is what has kept demand in check. But with new entrants making their way into the AFAs market, prices are expected to go down in the coming years and consequently, demand is expected to go up.
If EMC’s product portfolio gets integrated with Dell’s, the latter will be positioned to directly compete with International Business Machines Corporation (NYSE:IBM) in the multi-billion dollar data storage industry. In a head-to-head battle for market share, this acquisition will strategically put Dell at the top with its data storage segment revenues jumping from merely a little over $100 million to close to $3.0 billion, surpassing IBM’s by over threefold.
Here’s What This Means for EMC’s Stock Price
To keep it very simple, there are three kinds of secondary storages out there; the all flash arrays, the hard disk drives, and the hybrid arrays (a combo of HDD and flash). AFAs have the best performance but are relatively expensive, while HDDs are the cheapest but come at the expense of slow performance. Hybrids find a middle way. In the data storage industry, EMC is a market leader across the board with a portfolio of all of these storages. Dell is currently irrelevant in the AFA market but holds a small share in the hybrid and HDD market.
In a nutshell, if Dell plays this right, the EMC acquisition will likely prove a boon for the company. Amid this acquisition hullabaloo, however, VMware, Inc. (NYSE:VMW) stockholders (a subsidiary of EMC with EMC’s majority stakes) have suffered as their fate remains uncertain of whether the deal is closed.