Dell-EMC Merger Could Create The Biggest Cloud Federation

  • Dell is buying EMC with VMWare's assets.
  • VMware may be the strongest, and best-connected, cloud software operation in the world.
  • At 50, Michael Dell takes the place of EMC CEO Joe Tucci at the head of this federation.

The announcement that privately-held Dell will buy EMC (NYSE:EMC) for $67 billion shocked investors and EMC failed to achieve the $33.15 Dell price in Monday trading, ending at $28.35.

One reason may be that people are looking at this deal in isolation, and in isolation it seems to make little sense. How can Dell, which was said to be worth a fraction of EMC before the agreement, pull this deal off in the first place? And will the company have any financial ammunition left when that’s done?

The answer is that it can pull the deal off, and it will still have plenty of financial ammunition. EMC itself has about $7.7 billion in cash and short-term equivalents on its books. Dell has an unknown additional amount, and Dell, when it went private in the first place, built a network of deep-pocket private equity investors with plenty of clout to borrow the remaining cash needed to complete the deal.

Second, and most important, is that this is not a typical deal where a company is bought out to go private, because EMC owns 80% of Vmware (NYSE:VMW), which itself represents about 60% of the pre-deal EMC stock value. Loans can now be secured, and partners brought in, on a cloud software giant that, at 35 times earnings, is woefully undervalued next to rivals like Red Hat (NYSE:RHT), which presently trades at 72 times earnings in what is generally a down market. Red Hat itself, it should be noted, is now within 10% of its mid-summer high. So basically, Dell is buying EMC with VMware.

There are other moving parts within EMC that Dell could spin-off, in whole or in part, to pay back its loans quickly. There is a converged appliance venture called VCE, in which Cisco (NASDAQ:CSCO) still holds a stake, and in which Intel (NASDAQ:INTC) has invested, that could be carved up. Dell could put what is left of EMC’s networking business into Cisco through VCE and, with its partners, make that the centerpiece of its cloud hardware strategy.

There is also a Dell unit called SecureWorks, acquired in 2011, that could be spun-off, re-financed, or sold in whole or in part. Secureworks competes directly with hot stocks such as FireEye (NASDAQ:FEYE) and Qualys (NASDAQ:QLYS) in the data systems security arena.

Finally, EMC owns the bulk of Pivotal Software, a company building a cloud stack for the Internet of Things with cash from General Electric (NYSE:GE). That company, too, could be spun-off in whole or in part, either to the public market or through private equity.

EMC provides Dell not only with a cloud strategy, but with a host of fast-growing properties that can now be financed separately, spun out in whole or in part, or provide cover for the sale of slower-growing units like EMC’s own network storage or Dell’s PC business. With this deal Michael Dell has put himself, at age 50, into the position of outgoing EMC chair Joe Tucci, who has been anxious to retire for some time. He becomes the captain of a cloud federation, potentially the most powerful figure in the cloud industry, and he doesn’t have to answer to public shareholders except as he wants to.

The Dell-EMC merger is a good deal for Dell and, as parts of this federation emerge in the public markets, a good deal for EMC shareholders as well. You can participate, if you wish, by buying shares of VMware today, while they’re still stunned by the audacity of it all, and have the lowest-possible valuation.

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