Michael Dell taking Dell Inc. (DELL) private–why?

the deal

On February 6th, DELL confirmed the rumored buyout of the company by founder Michael Dell and private equity firm Silver Lake.  The board has approved an all-cash deal in which holders of Dell common will receive $13.65 for each share.

The structure of the private Dell isn’t 100% clear.  From press reports, Michael Dell will contribute his 14% holding in the company, worth $3.3 billion at the buyout price, plus $700 million in cash in return for a majority stake in the new entity.

Let’s assume MD’s $4 billion buys a 50% interest.  Given that the overall assets of DELL are being valued at $24.4 billion, this would imply that the private company will have $16.4 billion in debt to go with $8 billion in equity.  That’s a tripling of the financial leverage that publicly traded DELL now maintains–no great surprise for a private equity deal.

DELL is a mess

Profits peaked in 2005, when the company achieved a return on invested capital of an extraordinary 83%.  This year’s results (the fiscal year ends in January) will be around 40% lower than that high water mark, and will likely represent a 15% return on capital.  Strangely, the company has decided to celebrate this adverse turn of fortune by initiating a dividend.

In recent years, DELL has been attempting to transform itself from being an assembler of heavy, clunky (but inexpensive) PCs for mostly corporate users into a purveyor of corporate IT services, using IBM as a template.  Nevertheless, by far its largest expenditure since its profit peak has not been on service company acquisitions or on internal development.  Instead DELL has chosen to retire a quarter of its outstanding shares since 2005, at a cost of (I almost can’t believe the numbers) $22 billion or $23.80 a share.  With the stock was trading at around $8 before rumors of going private surfaced, this continuing decision represented $14 billion in lost value to shareholders.

Since the beginning of 2005, the S&P 500 has risen by 29.6% on a capital changes basis.  Over the same time span, Lenovo is up by 118%.  Hewlett-Packard is down by 12.7%.  Dell has lost 66.8% of its per share market value.  Acer and Asustek have been equally bad performers, although that’s cold comfort.

shock therapy?

That’s what I think this buyout is about.  It’s been clear for years that the traditional PC assembler model is broken.  AAPL’s success clearly demonstrates that.  Samsung has emerged as a very powerful competitor, as have Lenovo, Asustek and Acer.  INTC’s Chromebook initiative and  MSFT’s Surface both show frustration with the lack of competitive relevance of assemblers like DELL and HPQ.  Yet, as far as I can see, DELL hasn’t improved its PC offerings, or its service, much at all.

In my experience, mature companies can resist change in an almost unbelievably stubborn way–the source of the saying that “Turnarounds never happen.”  Maybe managers lack the skills needed to succeed in a new environment, so they simply can’t do a better job.  They may not understand the issues.  Or they may not be risk takers, preferring a mediocre-to-bad present to an uncertain, but possibly better, future.  In any event, they drag their feet.  What can one man do, even the founder of a company, in the face of widespread inertia?

Bring in a whole new management–a firm like Silver Lake that specializes in straightening out mature, underperforming tech companies.  The going private part of the maneuver is at least partly that it’s Silver Lake’s price for taking on the job.

some big DELL holders aren’t happy

Southeastern Asset Management, which owns just under 10% of DELL, is one of them  Reuters reports that there are at least a few others.

Even a cursory glance at a stock chart will tell you why.  Unless the firms in question bought DELL in the last couple of months,  or during the final days of the market meltdown in early 2009, they will be forced to recognize big losses from holding the stock.

They have some justification, since they’ve stuck with DELL through thin and thinner.  This is what value investors do.  They buy mediocre or weakly managed companies and wait for change to happen.  They’ve been right in this case that change would happen, except that it’s coming in a way they didn’t anticipate.

On the other hand, DELL probably needs much more radical surgery than the institutions ever imagined, meaning that it would best be done away from the requirements of public disclosure, from media attention and from the reach of short-sellers.  That way customer confidence is easier to maintain.






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