the DELL story heats up

latest developments

The New York Times reported yesterday that influential investment manager T. Rowe Price has joined the chorus of holders of DELL who are protesting that company’s board-approved proposal to be taken private by CEO Michael Dell and private equity firm Silver Lake at a price of $13.65 per share.

DELL’s largest institutional shareholder, Southeastern Asset Management of Tennessee, who we now know from a 13-D filed with the SEC owns 8.44% of DELL’s common (acquired at a price of just below $16 a share), seems to be leading the opposition to the deal.  


–Southeastern has published on its website an open letter to DELL, in which it outlines its argument that the company is actually worth about $24 a share, almost twice what the board has okayed as an acquisition price.  

–In the letter, Southeastern also gives a thumbnail sketch of a plan, using brokerage house earnings estimates, by which DELL could leverage itself (to the sky), pay shareholders a $12 special dividend and still be able to generate annual free cash flow of over $1 per share.

The NYT Southeastern has hired a proxy firm and a mergers and acquisitions lawyer.  In its letter Southeastern says it intends to pursue the matter through a proxy fight, lawsuits and, if I understand correctly, an appeal to the Delaware Chancery Court.

what I find interesting–and worth monitoring

–Southeastern is really upset, in a way I can’t recall ever seeing in a US-based institution.

It isn’t opposed to having DELL go private per se, only to the combination of preventing existing shareholders, ex Michael Dell, from participating, and what it sees as the low-ball price.

–Proxy fights are tricky things.  Why?  Individual investors support management overwhelmingly, even when it’s loony to do so.  It’s also hard to tell how much stock has been scooped up by arbitrageurs in the high-volume trading of the past month.  These guys aren’t in this for the long haul.  They want a quick profit and an exit.

Experience tells me it will be extremely hard for Southeastern to come up with enough votes to block the deal.  But it sure does seem motivated.

Always an advocate of the ad hominem argument (e.g., “You’re ugly!”), I wonder how the directors make out in this deal.

–Southeastern says in its letter it intends to avail itself of  “any available Delaware statutory appraisal rights.”

Here’s what I think this means:  if a tender offer is successful in acquiring 90%+ of a company’s stock, the buyer can go to court and compel the remaining 10%- to tender their shares.  That 10%- have recourse, though.  They can appeal to the court for a hearing to argue that the price is too low.  If successful, they (and no one else) receive the court-determined higher price.

I’ve only followed this kind of appeal once.  The process took three years.  During that period, the company in question deteriorated markedly.  It turned out in hindsight that the acquirer had paid a crazy-high price.  So the court stated the (now) obvious–that the original price was too much.  So the reluctant 10%- ran up a pile of legal bills and got the original acquisition price, only three years late.

I wonder how things will turn out this time.

nits (or maybe slightly bigger issues) to pick

I understand the Southeastern letter only has the bare bones of its valuation argument.  Still, I view DELL has having much less cash than Southeastern assumes.  Yes, it’s there as $$$ on the balance sheet.  But a lot comes from DELL being able to hang on to the money it gets from customers before it needs to pay suppliers–sort of like a restaurant that gets cash every day but only pays for vegetables, rent and power at the end of the month.  Another big chunk comes from advance payments from corporate customers for IT services.  That’s sort of like magazine subscriptions, where the publisher gets money as much as a year before he puts the last issue in the mail to you.  Yes, things are fine in both cases as long as the business expands.  But the money evaporates if the business begins to contract.  As I read the balance sheet, DELL’s cash, net of these timing differences and   debt, is around zero.

Borrowing a gazillion dollars does mimic what I imagine Silver Lake intends to do as/when it takes DELL private.  Pay that out in a special dividend as Southeastern suggests is an alternative to going private, however, and how is the now highly leveraged company ever going to pay the principal back?

I understand that Southeastern wants to use third-party figures in its public analysis, but I find it humorous that its authorities are:  a management whose performance has lost 2/3 of the stock’s market value in a rising market; and Wall Street securities analysts who, as a group, are notoriously optimistic and deeply beholden to company management.




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.