Monday, July 2, 2012

Dell to Acquire Quest Software for $ 2.4 billion

After weeks of rumors, Dell (DELL) announced this morning a deal to acquire Quest Software (QSFT) for $ 2.4 billion. From their press release:

"The addition of Quest will enable Dell to deliver more competitive server, storage, networking and end user computing solutions and services to customers," said John Swainson, president, Dell Software Group. "Quest's suite of industry-leading software products, highly-talented team members and unique intellectual property will position us well in the largest and fastest growing areas of the software industry. We intend to build upon the strong momentum Quest brings to Dell."

"Clearly, Dell's distribution, reach and brand are well recognized in the industry. Combine that with Quest's software expertise and award-winning systems management products and you have a very powerful combination for our customers and partners," said Vinny Smith, chairman and chief executive officer of Quest Software. "With this transaction, Quest's products and employees become the foundation for Dell's critical software business."

The deal is expected to close in Dell's fiscal third quarter.

Two-thirds of Dell's profit already comes from sources other than the PC*. So this deal will just further reduce Dell's dependence on that relatively unattractive business.

With Quest Software selling at roughly 15 times forward earnings, it's tough to be enthusiastic about the purchase when Dell could instead just buy back its own stock that's selling at very low multiple of earnings (though they've recently made it clear they plan to distribute 20-35% of free cash flow to shareholders via dividends and share repurchases).

The good news is that Quest's free cash flow has been quite a bit higher than net income in recent years. This is mostly due to deferred revenue and depreciation/amortization well in excess of capital expenditures. On that basis, the price being paid seems more reasonable.

The strategic fit of Quest with Dell in the context of where the company is going also has to be given appropriate consideration. Time will tell whether this turns out to be an important part of the transformation of Dell's core business.

Adam

Small long position in Dell

* For the one-third that is PC, most is not the consumer. I point this out because somehow Dell seems to be viewed as mostly a consumer PC business. Even without the Quest deal, it certainly is not at this point.
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