Why Cisco Should Buy Dell

[qi:012] The skirmishes that have been taking place between Hewlett-Packard (s hpq) and Cisco (s csco) as each tries to encroach on the other’s territory in an effort to own both the enterprise and consumer IT markets have been heating up over the past year. HP has been strengthening its ProCurve line of enterprise networking products, an area where Cisco dominates. Meanwhile Cisco has moved into one of HP’s traditional markets with the launch of its own enterprise servers, dubbed the Unified Computing System. That prompted HP to retaliate by inking a deal with Riverbed, long one of Cisco’s data networking archrivals.

As I’ve argued in the past, there are still other moves that HP could make to fend off Cisco in enterprise IT. But those would be rendered moot if Cisco decided to pull the ultimate offensive move — that of buying Dell (s dell).

The Math

Even in the face of the current economic downturn, Cisco could afford to buy Dell. It had some $41 billion in cash and assets as of the end of its latest fiscal quarter, though it would likely look to buy Dell using a combination of cash, debt and stock. The combined market capitalization of Cisco/Dell of around $150 billion would easily trump rival HP’s $96 billion.

The margins on Dell’s products are much thinner than Cisco’s have traditionally been (17 percent vs. Cisco’s 64 percent in their two most recent quarters, respectively), but combine the two and you have a very profitable business. My rough calculations — without taking any potential merger synergies into account — put a combined Cisco/Dell at $20.4 billion in top-line revenues per quarter with $7.3 billion in gross profits (36 percent). I am willing to bet that with synergies the combined company would have gross profits of over 40 percent — compared to HP’s most recent quarterly gross profits of just 24 percent.

The Products

In a move to further penetrate the consumer market, Cisco recently purchased Pure Digital Technologies, maker of the Flip Video camcorders. In the meantime, it’s seen good growth in its Linksys consumer networking products -– at least in areas where they compete with HP. However, while those products are a step in the right direction for Cisco, they won’t help the company win out against HP. But if Cisco bought Dell, it would get a wealth of consumer products that are directly competitive with HP’s, among them laptops, desktops, printers, digital cameras, monitors and more. Increasingly, all of these devices need to be networked together in the home, and Cisco has the technology to do that in spades.

Beyond the strategic fit on the consumer side that would result for Cisco, such an acquisition would make good strategic sense for Dell, too. Dell has always wanted to be a major player in enterprise IT, a traditional market for rival HP. To that end, the company has its PowerConnect enterprise networking products, and at the start of the year announced a partnership with Cisco focused on the next generation of data center switching — a partnership focused on battling the common enemy of HP.

In the meantime, Cisco unveiled its first enterprise servers with its UCS product line. Dell’s PowerEdge enterprise servers and blade servers would complement UCS and enable the combined company to sell a complete enterprise computing solution that could rival HP’s ProLiant and Integrity products.

The Result?

If Cisco wants to triumph over HP, the value proposition of a combined Cisco/Dell is compelling. Cisco/Dell would continue to dominate over HP in enterprise data and voice networking, would be a very formidable competitor against HP in enterprise servers and be well positioned against HP in the consumer markets.

The question is, what would HP do in response? Would it move to trump Cisco in the enterprise storage market by buying EMC and its crown jewel, VMware? Perhaps it would move up the enterprise IT stack and acquire Citrix (s ctxs) for that company’s enterprise application suite? One way or another, if Cisco were to acquire Dell, HP would see it as a declaration of all-out war.