Jim Jubak: Why Dell, Hewlett-Packard are bidding for 3Par

Jubak's Journal8/30/2010 7:30 PM ET

Dell-HP bidding war: The real story

Why are the tech giants willing to pay nearly $2 billion for a data storage company that isn't turning a profit?

By Jim Jubak

On the surface, bidding a couple of billion dollars for a company that hasn't made an operating profit in the past five years looks nuts.

Dig deeper, though, and the battle between Dell (DELL, news, msgs) and Hewlett-Packard (HPQ, news, msgs) to buy data storage company 3Par (PAR, news, msgs) doesn't look nuts -- it looks insane. 3Par's sales are projected to hit all of $235 million for the fiscal year that ends in March 2011. Earnings before interest, taxes, depreciation and amortization, or EBITDA, are projected at just $21 million.

On Aug. 26, Dell proposed paying $1.5 billion for 3Par. Later in the day, Hewlett-Packard bid $1.7 billion. Each bid came to roughly 80 times EBITDA for 3Par. Then both raised those bids the next day, Friday, with HP ready to pay nearly $1.9 billion.

Aren't these companies certifiable?

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, in which companies carefully figure out how to get the best value for the money they're about to spend. This is the era of cash as a bludgeon.

Money: It's the gas, gas, gas

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 that is unable to climb off the canvas for years. At best, such spending might crush a competitor forever.

Put the Dell-HP contest over 3Par into competitive context, and it starts to make sense despite the insane valuation awarded to the storage company.

Once upon a time Dell was the top dog among the makers of personal computers. Then Hewlett-Packard began an aggressive strategy of acquisitions that not only moved it into the top position among PC-makers but also built new strengths for the company in services, storage and smart phones (Hewlett-Packard hopes, at least).

By the time Dell noticed the changes in its marketplace, it was forced to play catch-up.

Nothing sums up that competitive deficit better than Dell's response to Hewlett-Packard's May 2008 purchase of Electronic Data Systems, a giant information technology services provider, for a tad less than $14 billion. That purchase vaulted Hewlett-Packard to No. 2 behind IBM in the IT services market.

When Dell tried to catch up in September 2009, the best acquisition it could come up with was the much smaller Perot Systems for about $4 billion.

Beating up on Dell

The shift in relative market power during the past five years has been stunning.

Hewlett-Packard has always been larger than Dell in terms of revenue, 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.

Technology companies have the power to turn slight changes in revenue into huge moves in earnings. And no one who understands that 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, despite much smaller revenue, recorded operating earnings 20% greater than HP's. 2006 saw a huge plunge: Operating earnings at Dell were just 65% of those at HP. In 2007, the drop got worse: Dell's operating earnings were just 36% of those at Hewlett-Packard. They slumped to 32% of HP operating earnings in 2008 and 2009.

Continued: Dell needs a deal

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