Storage area network vendor 3Par Inc., while not an unknown among tech watchers, was hardly an IT household name before last week’s bidding war between Dell Inc. and Hewlett-Packard Co. Dell’s Aug. 16 offer of $1.15 billion for 3Par was already a substantial premium over the stock’s value, but HP’s one-upmanship has driven the valuation up stratospherically.
FT.com‘s Lex blog noted, “HP may trump its rival – but to do so it has put a valuation on 3Par that is, frankly, bonkers … 3Par has not made an operating profit in five years. Fixed assets at the end of last year were worth just $58m. On sales of $235m in the year to March 2011, analysts expect 3Par to generate $21m of earnings before interest, tax, depreciation and amortisation. HP intends to pay almost 80 times those profits.”
And at the time of that blog post, the bidding was still at $1.6 billion. Within two days, it would go to $2 billion. Just what the heck is going on here?
“The intense contest for 3PAR is reflective of both Dell and HP’s goal to expand beyond personal computers to markets that could generate higher profits … HP exited the recently concluded third quarter with a strong cash balance, which indicates that it could easily snap up an acquisition such as this one,” according to Zacks Analyst Blog.
That doesn’t quite square the circle. At the time of the posting, HP’s $1.6-billion offer was a 33 per cent premium over Dell’s original bid, which, according to Zacks, was itself an 86 per cent premium over 3Par’s previous day closing share price.
“You’ll notice that Dell is engaged in incremental bidding, while HP is jump bidding,” says M&A Law Prof Blog. “That’s because HP has no way of knowing what Dell’s private valuation of 3Par is, so it’s trying to use a version of ‘shock and awe’ to knock Dell out of the bidding. Dell, on the other hand, is confident that it will always have the last look, so it need do no more than add $0.10 to HP’s last bid. A week ago, this company was trading for about $9 (per) share. Last bid was $30 … something like $2 billion. I suppose it’s only money.”
That explains how the valuation got so high, but not why.
Chuck Hollis, vice-president of global marketing and chief technology officer of storage giant EMC Corp., speculated at the outset, before HP came out of the bidding closet, that the latter was driving Dell’s already outrageous valuation of the company. “Both HP and Dell move a lot of gear ‘downmarket’ — targeting smaller IT shops that tend to value simplicity and convenience (over) strong technical, solution or services differentiation. Different-sized IT shops tend to value different things.
“And in these smaller IT organizations, you’ll often notice that servers and storage tend to come from the same manufacturer. They’re positioned, sold and supported together as a complete package from a single vendor. Sure, there’s the occasional IT group that splits out server and storage as independent decisions, but the predominant buying mode here is ‘bundle’ … Rarely does anyone make a standalone decision to buy HP storage and use it with, say, IBM servers.”
That makes sense, strategically. But financially? When Dell matched HP’s $1.8-billion bid, FT’s Lex did the math: “Hypothetically matching HP’s latest $1.8-billion offer, Dell would have to generate profits after tax of $180 million from 3Par in order to make a respectable return of, say, 10 per cent in five years. At Dell’s current 29 per cent tax rate, that would require 2015 revenues of $1.2 billion, a sixfold sales increase in five years, not to mention spectacular profitability. Who needs rationality when desperation and blind optimism conspire so well? … Few things inspire a loss of rationality quite so much as the fear of missing out. The phenomenon is apparent around buffet tables, in one-day sales, and now in the pursuit of computer storage company 3Par.”