Dell finally nabs Quest for $2.4bn

Swallows Toad in the whole

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Updated After a minor bidding war with Insight Venture Partners, Michael Dell has prevailed with a bag of cash stuffed with $2.4bn (£1.5bn) to take over Quest Software - a peddler of a hodge-podge of systems, database, performance and access management tools as well as data archiving software.

Dell has not historically broken out its fledgling but growing software business from its peripherals arm, but said today that after acquiring Quest the company's software unit would have generated $1.2bn in revenue if you combine its own software sales with those of Quest for last year.

The important thing for Dell, and why it is ready to pay $28 a share or a 44.3 per cent premium for Quest based on its closing price on 8 March, is to build a growing and profitable software business.

Insight Venture Partners offered $23 a share, or around $2bn, to take Quest private on 9 March, but allowed Quest to shop around for a better deal.

The Dell-Quest talks were on-again, off-again but in the end, Insight Venture Partners, which brought in Vector Capital to help foot the acquisition bill, decided that the premium Dell was willing to pay was too rich for its blood.

The fact that Dell has announced the deal – it never confirmed that it was in talks with Quest at all – presumably means that it has pretty much locked up the Quest buy and does not expect a rival to arrive with more money on the table.

Dell is not just buying a portfolio of software, but a pool of software experts and a very large customer base.

Quest is based in Aliso Viejo, California and, according to Dell, has 3,850 employees: 1,279 are software engineers in its research and development organisation and 1,440 are direct sales reps (331 of them being former software engineers). That leaves 1,131 people doing back office and other work, and perhaps many of these employees will be cut as Dell absorbs Quest into its much larger organisation.

Dell will have to cut duplicate costs if it is to extract profits out of Quest. In 2011, Quest grew its revenues by 11.9 per cent to $858.2m, but net income was cut in half to $43.9m. Dell's not worried about the bottom line at Quest. The company has 86 per cent gross margins and had $195m in cash flow from operations in 2011.

Moreover, Quest has over 100,000 customers worldwide using a variety of tools that it has created or acquired over the years. Quest has been on a tear buying up server virtualisation tool providers, including VKernel last November and Surgient, a quality assurance tool for virtual server environments.

These tools were married to the company's FogLight physical system management tools, which Quest acquired in 2000. Quest also bought Provision Networks for its virtual desktop monitoring utilities in 2007, and ChangeBase last October for its tools to babysit application virtualisation and virtual desktop infrastructure (VDI) setups driven from servers. The company also sells the popular Toad database manager as well as NetVault backup, vRanger virtual machine replication, FogLight application performance monitors, a suite of Windows Server management tools, Quest One user identity and access management and Quest Workspace.

This stack of software represents about 72 per cent of Dell's software revenues, based on the 2011 revenue stream, once the deal closes. And importantly for the Texan tech titan, this enterprise software segment has a $30bn addressable market that is projected to grow at a 10 per cent compound annual growth rate between now and the end of Dell's fiscal 2016 year.

Update: In a conference call with Wall Street analysts to go over the deal, Brian Gladden, Dell's CFO, said that the deal had been approved by the boards of both companies and pending regulatory and Quest shareholder approval, the acquisition of Quest should close sometime in Dell's third quarter, which ends in November.

Gladden said that more than half of Quest's revenues were recurring maintenance or licensing fees, and that in addition to the software experts and broad portfolio, Quest also brought Dell 4,000 channel partners who pushed about 40 to 45 per cent of Quest's sales in 2011. Dell has 20,000 direct sales people and 100,000 channel partners, but it is the direct sales and channel partners of the acquired Quest that will be the foundation for the Dell software biz going forward. Dell is, of course, counting on significant cross-selling and up-selling across its broader sales team and channel to help push Quest products.

Vinny Smith, CEO at Quest, said that 2011 was "a bumpy year for sure" at Quest, with its revenues impacted by the earthquake and tsunami in Japan as well as by some product transitions. Moreover, after a slow 2009, 2010 was a bumper year and made for a tough compare, which is why when you extract Quest's own acquisitions in last year as well as the effect of currency on its sales the company's software license sales actually dropped. But the first quarter is back to the normal 8 to 10 per cent average revenue growth that Quest enjoyed over the first decade in the 2000s.

Dell and Quest software stacks

Lining up the Dell and Quest software stacks

The deal is not yet done so Dell has not yet figured out a complete product roadmap for its software lineup, but John Swainson, a long-time IBM software exec who also ran CA Technologies who was hired to run Dell's software biz back in February, gave some hints.

"We're not looking randomly at software profit pools," said Swainson on the call, but rather at products that play to Dell's strengths in the PC, server, storage, networking, and services areas. "This is now the core asset of our software business."

Swainson said that there were some obvious synergies between the SecureWorks and SonicWall security products that Dell has acquired recently and the identity management products from Quest; ditto for the recently acquired AppAssure (recently bought by Dell) and NetVault (recently bought by Quest) backup and archiving products. Swainson said the deal was "highly synergistic" in terms of both products and customer bases, and added that initially the various Dell products would be sold side-by-side with an eye towards integration where it makes sense. Quest has built an integration framework for its various management tools, and this was particularly appealing to Dell, which would snap other tools into it.

As for paying for the deal, Gladden said that Dell was looking carefully through the Quest intellectual property and operations and would be able to argue that over 50 per cent of the value of the deal is for assets developed or controlled outside of the United States and therefore cash piles outside of the States could be used to fund more than half the acquisition. ®

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