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Headwinds

I was sitting at Carl Icahn's dining room table with Icahn and his wife, eating Mrs. Icahn's meat loaf.

It was a lovely spring evening-Wednesday, May 29, 2013-and Carl Icahn was trying to take my company away from me.

It was a truly surreal moment, in so many ways.

That May evening was almost the precise midpoint in a nine-month drama in which the personal computer company I started in my freshman dorm room at the University of Texas in 1984, the company with my name on it, tilted E and all, almost slipped away from me-and then changed forever, changing me along with it.

I'd like to tell you that story, and a couple of other ones besides.

The year 2005 dawned bright with promise for Dell Inc. Apart from the blip of the dot-com bust five years earlier-a correction that affected not just us but tech companies across the board-Dell had enjoyed a pretty uninterrupted run of growth in revenue and profits and cash flow for two decades. In January 2005 our share of PCs sold stood at a robust 18.2 percent. In February Fortune named us the most admired company in America. Dell, they wrote, was Òthriving in an industry that may technically qualify as being in the poorest state in the Union. Its profits in this margin-squeezed business soared 15 percent in 2004, a feat that Dell makes look boringly routine. And now itÕs the first PC maker to hold the rank of AmericaÕs Most Admired since the original ÔPCÕ maker, IBM, logged off in 1986.Ó

By September, though, things had begun to change. A lot. Though our profits rose 28 percent in the second quarter, total revenue was several hundred million dollars short of projections. We were, The New York Times reported, "wrestling with the same question facing other mature technology companies that ranked among the highest fliers of the 1990s: How to increase revenues when it is already so big?" Compounding the problem was the fact that personal computers and laptops, which accounted for roughly 60 percent of our sales, were no longer the rich profit center they used to be. As prices had dropped over the course of the year, we'd had to sell that many more PCs just to keep up with the previous year's revenue.

Interviewed by the Times, our CEO Kevin Rollins blamed himself for the shortfall. "Frankly," he said, "we executed poorly on managing overall selling prices"-especially on machines sold to consumers.

Yes, you read that correctly; it wasn't a typographical error. Kevin Rollins, not I, was CEO of Dell Inc. that fall. I'd stepped aside from the position in July 2004 and Kevin had taken over-though taken over isn't exactly the right way to put it. I remained chairman, and the two of us continued to run the company together as we had for a decade; not much really changed except for our titles.

And so if there was blame to be laid for that revenue loss, I shared it. But it quickly became apparent in late 2005 that the underperformance wasn't an anomaly: Dell was beginning to hit serious headwinds. For one thing, our competitors were getting smarter. Companies like Hewlett-Packard, Acer, and Lenovo, companies we'd always soundly defeated with our build-to-order model, had gone back into their cave and figured out how to duplicate many of our supply chain innovations. Meanwhile, build-to-order itself, so effective at addressing the many combinations and permutations of desktop computers, lost its advantage as the industry shifted from desktops to less easily customized notebooks. Customers were starting to focus more on services and solutions as value transitioned from the fundamental client product, the PC and related peripherals, to software, servers, and the data center.

It took us a little bit longer than we would have liked to figure all this out.

And then there was a Dell plus that was subtly turning into a minus: for a few years we'd been prioritizing profit over growth and share, and a company's success is always a balance between those three. Our profits were strong in the 2000s, but now our share was eroding. And that can be a slippery slope.

We needed to build new capabilities, we needed to invest in new areas, and we needed to move fast.

In 2007 I returned as CEO-both a symbolic move and a practical one-and we embarked upon a major merger and acquisitions initiative, starting with the purchase of the data storage company EqualLogic, for $1.4 billion. The financial crisis of 2008 threw a temporary wrench into our plans, but the following year we restarted the program by buying Perot Systems (for $3.9 billion), and in 2010 we really went on a roll, acquiring storage, systems management, cloud, and software companies such as Compellent, Boomi, Exanet, InSite One, KACE, Ocarina Networks, and Scalent.

In 2011, to round out our enterprise capabilities, we bought Secureworks, RNA Networks, and Force10 Networks. And in 2012 we made still more key acquisitions in software and security, including Quest Software, SonicWALL, and Credant Technologies. For fiscal year 2012, Dell achieved its highest-ever revenue, earnings, operating income, cash flow, and earnings per share.

Maybe it was the calm before the storm.

But in the meantime, all was not well at Dell. We'd tried to enter the smartphone and tablet markets, without success. We'd even come up with what was known at the time as a "phablet"-a five-inch Android device called the Streak. It didn't exactly streak lightning across the sky. (For one thing, most of the profit went to Google.)

By 2012 our PC sales had fallen by double digits, and our share had continued to erode-by year-end, with the heavy weight of Windows 8's failure dragging us down, it had dropped to 10.5 percent-and now profit was declining as well. Our market capitalization had fallen below $20 billion.

In late 2012 our share price would sink almost to penny-stock territory: less than $9, a plummet from the $15-to-$17 levels it had seen in 2009 through 2011. The conventional wisdom, shouted through a thousand megaphones on the internet as well as on CNBC and other media outlets, was that the PC was doomed, and that therefore Dell was pretty much doomed too.

Our shareholders were not happy, myself included.

Despite our spectacular success over the years-anyone who'd bought Dell shares back at the beginning and held on to them had earned 13,500 percent on their investment, twenty-seven times greater than the 500 percent return on the S&P 500 during the same period-our stockholders were worried about the company's future. Still I had the full support of our shareholders, who in July 2012 reelected me to serve as CEO and chairman of Dell with over 96 percent of the vote.

And I was trying to reassure them. "We're really not a PC company anymore," I told Fortune editor in chief Andy Serwer in July 2012, at Fortune's Brainstorm Tech conference in Aspen. But Andy was a tough sell. "Is it really the case that you're not a PC company now or that you don't want to be a PC company in the future?" he asked me.

I reminded him that in the last five years we'd made a concerted shift in our business, toward end-to-end IT solutions: a complete set

of capabilities for customers, from their data centers to their client systems to security, software systems management, storage, servers, and networking.

I told Andy that Dell was really in four businesses now.

First came the client business, which was itself transforming with all that was going on in mobility and client virtualization-which in turn brought new needs in terms of security.

Next came the enterprise data center. I reminded Andy that we'd built a tremendous business in storage and networking, fueled by all those acquisitions-about twenty-five in the last three or four years. I said that in case anyone had forgotten, about one-third of the servers in North America were made by Dell. Cloud and virtual infrastructure had become very big for us.

Then there was our software business, centering around systems management and IT security. I said we were seeing around twenty-nine billion security events per day; we were protecting tens of trillions of dollars of assets for the biggest banks and financial services firms in the world.

I called Andy's attention to the fact that of the 110,000 people at Dell, almost half-a full 45,000-were in our fourth business, services, helping companies capture value from all the IT needs out there.

"So we're right in the middle of some of the stickiest challenges out there," I told Andy. "How do you connect older applications to cloud applications? How do you secure and modernize IT environments and bring them off mainframes and onto the X86 platforms? Put them in the Dell Cloud and do it more efficiently."

Dell, I said proudly, was a much different company than it had been four or five years ago.

Andy looked a little bemused. "Am I wrong, or did I not hear you mention PCs at all in that little soliloquy?" he asked.

Even smart people, it seemed, were hung up on that one subject.

Andy then put a polling question up on the screen behind us: "Last year desktops and laptops accounted for 54 percent of Dell's revenue, down from 61 percent in 2008. How big will Dell's PC business be in five years?"

Possible answers were: (a) 50-54 percent (about same as today); (b) 40-50 percent; and (c) 39 percent or less. Choice C got the most votes by far.

The correct answer was A.

I told Andy that with all due respect to his poll, a better way to think about the question of our PC business vis-ˆ-vis our other businesses was in terms of revenue and profit. Let's say (I said) you sell a billion dollars' worth of PCs, versus a billion dollars' worth of software: those two transactions would have very different characteristics in terms of free cash flow and margin. Therein lay some of the difficulty in looking at Dell strictly from a revenue standpoint. Our business mix was definitely shifting, I repeated.

Hoping the message was starting to sink in.

I believed passionately in everything I told Andy at Aspen. And in the days, weeks, and months that followed, the business press kept pushing the narrative that Dell equaled PC, and the PC was dying.

And our stock continued to swoon.

I'll freely admit that some part of me smarted at seeing our share price sink so low. The company had my name on it; after my family, it meant everything to me. But my wiser side saw an opportunity for the company. Back in 2010 I bought a big block of Dell stock in the open market, confident that the share price would rise. (There are very stringent rules about when and how an insider like me can buy or sell our stock: soon, but not too soon, after quarterly earnings have been announced. Needless to say, I followed them.) Yet it also occurred to me that if I-with help from others, of course-could buy back all the stock, our transformation as a company could proceed without the tyranny, the ever-ticking shot clock, of a quarterly earnings report. Going private would open up the possibility of dramatically accelerating the growth of the company and allow us to have a far greater impact in the world.

Others had the same thought.

In 2010, at a Sanford Bernstein conference, an analyst named Toni Sacconaghi had asked me if I'd considered taking the company private.

"Yes," I said. My monosyllable hung in the air. There was a little laughter in the room.

Sacconaghi smiled. "That's more succinct than I would think," he said. "What would be a galvanizing event for you to consider it much more seriously?"

"No comment," I said, feeling I may have already said too much. I smiled back.

Fast-forward two years. In late May of 2012, a month and a half before the Aspen conference, I had a meeting at our Round Rock, Texas, headquarters with several officers of Southeastern Asset Management, a Memphis firm that was the second-largest shareholder (some 130 million shares) of Dell stock after my wife, Susan, and me. These meetings happened on a regular basis right after we'd announced our quarterly earnings, but this meeting was different, because in the midst of the customary drone about numbers and projections, Southeastern's chief investment officer, Staley Cates, told me he felt we should take the company private.

"Can you tell me more?" I asked him.

"Let me get back to you," Cates said.

This, frankly, made me nervous. It wasn't the idea of going private itself that worried me; it was the fact that our second-largest stockholder was bringing it up. I had no clue what Cates was driving at. Obviously he wanted to increase the value of his shares, but was he saying that he wanted me to buy him out? Or was he saying he wanted to help me take the company private? What was he saying? I went over to the other side of the building and talked to Larry Tu, our general counsel, and Brian Gladden, our CFO. "What do we do now?" I asked them.

"Ask him how that would work," Brian said. "Ask if he has a financial model he'd like to share."

So I asked, and Cates sent me a simple spreadsheet that outlined his idea. I sent the spreadsheet to Gladden, and Brian sent it to a banker he knew at one of the major investment banks. And the banker analyzed the idea and told us it didn't hold water. "Too complicated, too much debt; not gonna happen," he said. "Forget about it."

So we forgot about it. Then something very interesting happened.

As I was taking off my microphone backstage at the Aspen Q&A, a guy-a few years younger than me, fit-looking-came up and introduced himself. His name was Egon Durban, he told me, and he worked for Silver Lake Partners.

"Hey, I'd love to meet with you about an idea I had," he said. "I have a house in Hawaii near yours-can we get together sometime?"

Now, people come up to me all the time, and I'm polite, but . . . people come up to me all the time. If this Egon Durban had been from a company I'd never heard of, I would have told him, "Sure, call my office," and we'd never speak again. But Silver Lake was a major private equity firm with a great track record and a deep expertise in technology (and whose first fund I'd invested in when it started up in 1999), so I gave Durban my email address. And when I looked him up, I saw he was one of Silver Lake's four managing partners.