Dell to Buy $16 Billion in IBM Parts
Dell Computer agreed to buy $16 billion worth of IBM components during the next seven years, harnessing Big Blue’s vast research and development abilities as it aims for a bigger slice of the market for more profitable, higher-end computers and related products.
IBM will climb from being one of Dell’s top 10 suppliers to being No. 4 or 5. “If all goes well,” Dell said Thursday, it could soon rank behind only microprocessor supplier Intel and operating system maker Microsoft.
“The industry is really running away from us faster than we can keep up,” said Dell Senior Vice President Mike Lambert in announcing the largest computer-supply deal of its kind. Dell spends about $350 million a year on designing new products, compared with the more than $5 billion spent by IBM.
The contract also could set the stage for Dell to use IBM’s service division for such big-ticket items as its network servers, which connect desktop computers, and even for IBM to begin a graceful exit from its own flagging personal computer operation.
“IBM ought to get out of parts of the PC business, where I don’t think they can compete well long-term with [low-cost specialists] Dell and Compaq,” said Merrill Lynch analyst Steven Milunovich. “Dell is a little weak on the technical side, and this allows them to differentiate themselves relative to Compaq and [Hewlett-Packard]--and even IBM--as they move up into the enterprise space” of more powerful computers.
Shares of both IBM and Dell jumped sharply on the news, but stocks of smaller companies didn’t tag along since the massive alliance makes two dominant players even more powerful.
IBM ended the day up $4.25 at $171, and Dell rose as much as $3.81 to $84.75 before sliding back to close at $81.88. The agreement solidifies Dell’s role as a super-efficient builder of computers from outside parts for direct sales to businesses and consumers.
“This is a new world of partnerships,” said analyst Jon Oltsik of Forrester Research. “You’re going to have people that are very good at assembling technologies and people that are very good at manufacturing technologies. If I’m HP today, or Compaq, this has really got my attention.”
Dell’s share of the U.S. personal computer market has more than doubled from 7.9% in 1996 to 16% in 1998, according to San Jose market researcher Dataquest, while IBM’s share sagged from 9.1% to 8.9%.
Computer components contribute less than 10% of IBM’s revenue, but sales have been increasing at 40% a year in the 5-year-old division. With fast-growing Dell cemented as one of its largest customers, that rate is sure to accelerate.
The nonexclusive arrangement will send IBM storage devices, networking and display technology, custom logic chips, static random-access memory and other components to Dell, and the companies will cross-license patents.
“We’ll work collaboratively with them as they develop technology, giving them our input and actually influence the process,” said Dell spokesman Jerele Neeld.
More disk drives will be one of the first major pieces of the agreement, although Dell said it would continue to buy supplies from Seagate and Quantum. Dell tends to pick a few key suppliers for broad categories, since that reduces its overhead in configuring different systems. Seagate stock lost $1.63 to close at $28, while Quantum added 13 cents to $19.63.
Compaq fell 56 cents to $33.31.
In a way, Dell is outsourcing a major portion of its research and development, said analyst Daniel Kunstler of J.P. Morgan in San Francisco.
“They’re going to try to marry their direct model to an increasing range of products,” Kunstler said. “That’s how they’re going to make their money.”
Dell Chief Executive Michael Dell has resisted calls to focus on cheaper consumer PCs after the company’s revenue growth slowed to 38% last quarter after two years above 50%. Compaq and other computer companies have also reported slowdowns in the past month.
Instead, Dell said in an interview this week, he wants the company to stay where it’s most profitable and where customers won’t be frustrated with short-lifespan machines.
“If we entered that segment, we could grow even faster, but our company is running pretty hard to grow at the rate we’re growing at,” Dell said. “It doesn’t seem like we’re forgoing a lot of opportunity.” Dell shares have been the top performer in the Standard & Poor’s 500-stock index for two of the past three years as its revenue soared to $18.2 billion.
IBM, with $81.7 billion in revenue during 1998, has been increasingly emphasizing its technology sales to computer companies, which last year brought in a profitable $6.6 billion in revenue. Other customers include Apple, Sun Microsystems and Compaq.
IBM spokesman Tom Beerman said he couldn’t imagine IBM leaving the market for PC sales through distributors, a market it helped redefine. But he agreed that IBM is focusing on service and higher-end machines.
“They’ve gone from clear leader to maybe the third or fourth supplier in a climate where people are literally giving away free PCs,” said analyst Oltsik. “It doesn’t make sense for IBM to pursue it.”
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Powerhouse Dell
The $16-billion deal between Computer Corp. and IBM is expected to help both companies, which have been enjoying sales and earnings increases over the last few years. Revenues and earnings, in billions:
IBM
Revenue: $81.7 billion
Earnings: $6.33 billion
Dell
Revenue: $18.2 billion
Earnings: $1.5
Sources: Bloomberg News
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* BLUE-CHIP SURGE: IBM helped pace a 191-point jump in the Dow. C3.
