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Dell Must Get In Takeover Mode

Alexei Oreskovic

Dell(DELL Quote) has never been keen on mergers and acquisitions.

But as the company strives to climb out of its doldrums, a shopping spree might be just the thing.

The company formerly known as the world's No. 1 PC maker is on a mission to revive slumping sales and profit margins, with founder and CEO Michael Dell vowing to shake up everything from internal operations to its famous distribution model.

To overcome its weakness in the consumer market, Dell has established a new global consumer division and enlisted former Motorola(MOT Quote) executive Ron Garriques, whose pedigree has some investors dreaming of a new generation of Razr-like gadgets.

The only problem is that Dell is no innovator -- a point made clear by last week's underwhelming new line of consumer notebooks.

Bringing a marquee name into the fold is great, but even Apple's(AAPL Quote) Steve Jobs would be challenged to innovate at a company that spends less than 1% of its revenue on research and development.

In the first and second quarters of 2006 (the last for which data is available because of an SEC investigation into Dell's books), Dell spent $129 million and $128 million on R&D, equivalent to 0.9% of total revenue.

Dell spokesman Bob Pearson says the company is devoting significant attention to its design capabilities, but would not comment on R&D spending levels.

To watch Janet Al-Saad's video take of this column, click here.

But with $12.3 billion in cash and investments on its balance sheet, Dell's consumer ambitions are not limited to what it cooks up in house. And because the ongoing SEC accounting investigation has temporarily halted Dell's share buybacks, the cash isn't being put to use.

Roger Kay, president of the research firm Endpoint Technologies, expects Dell to start making more acquisitions.

But he questions how much benefit there is to buying new technology in the standardized PC business.

From an innovation standpoint, there isn't that much value in a PC company, says Kay, who believes that the real value is in the design team. "If you wanted those design resources, you'd be better hiring those individuals than buying the whole company," he says.

That said, even R&D heavyweight Hewlett-Packard(HPQ Quote) regularly looks outside the company for new ideas and technology to differentiate its PCs.

H-P recently displaced Dell as the world's No.1 PC maker.

Since Michael Dell returned to the CEO spot in January though, Dell's stock is up roughly 19%, as investors look for the PC maker to get back on track. Dell's shares set a 52-week high Monday, hitting $28.98 in midday trading.

Dell's Pearson says the company is interested in doing some M&A deals going forward, though he says the company is thinking about potential acquisitions that fit into its services business.

Dell has already shown a willingness to look outside its walls for innovation in the consumer market, acquiring Alienware, a maker of video game PCs, in 2006. In that case, the idea was to marry Alienware's innovative products with Dell's operational efficiencies and purchasing power.

As Dell seeks entry into new consumer markets, such as handheld gadgets, smartphones or ultramobile PCs, the Alienware merger could prove a worthwhile blueprint for future deals.

There's also plenty of technology that could be incorporated into Dell's existing notebooks to make them unique. The Preface technology developed by PortalPlayer (now part of Nvidia(NVDA Quote)), which integrates a small LCD screen into a notebook case, is an example of a feature that can make a PC stand out from the crowd.

Chirag Vasavada, a hardware analyst at T. Rowe Price, which owns Dell shares, says a more deal-happy Dell might not be a bad thing.

"From an investor perspective, I want to see that cash deployed in a way that generates the most return on invested capital," says Vasavada. "If they can do a deal where they can generate excess returns relative to their cost of capital, great. If they can't, give me the cash back."

But Vasavada isn't convinced that Dell needs to come up with the next great gadget to succeed in the consumer market.

"People thought their products were dull and boring," says Vasavada. "They just need to close the gap and be competitive. They don't have to differentiate."