Dell’s buyout underpriced;T Rowe Price’s costly mistake

the Dell leveraged buyout

Three years ago, Michael Dell decided to take the company he founded private in a leveraged buyout.  Last week, the Delaware Chancery court ruled that the buyout price was woefully low.  It said that a fair offering to shareholders would have been $17.62 a share (how precise!), not the $13.75/share actually paid.

Dell does not have to compensate many former shareholders, however.

What’s this all about?

Delaware rules

Most US companies are incorporated in Delaware, where the rules are well-tested and generally favorable toward business.  In Delaware, if holders of 90% of the outstanding shares of a takeover target accept the acquirer’s offer, the remaining 10% can be forced to do so, too.  Other US states and other countries may have different thresholds, but they also typically have similar rules to eliminate potentially bothersome small minority holdings.

Minorities aren’t completely without rights in Delaware, however.  They are allowed to refuse the offer and appeal the valuation in court.  This is a long and expensive procedure–three years in the Dell case.  At the end of the day minorities are not allowed to keep their shares.  The issue is solely about the price they get for selling them.  (Shareholders who are in the 10% because they don’t vote, or who don’t participate in the lawsuit, just get a check in the mail for the original takeout price.)

This is what happened with Dell.  It’s also the reason that Dell only has to compensate those who sued.  The vast majority of former Dell shareholders freely accepted a takeover offer that we now know was way too low.

T Rowe Price 

The money management firm’s internal analysis was that the Dell offer was inadequate.  It also appears to have taken part in the suit.  But the firm somehow made an administrative error in 2013 and voted to accept the Dell offer, not to protest the valuation.  The court ruled that T Rowe Price is stuck with that decision, even if it intended to do the opposite.  So it won’t benefit from last week’s ruling.  In fact, it is going to have to figure out how to pay people who owned funds containing Dell shares the $194 million they would have had, were it not for the voting mistake.  This will likely be a real pain in the neck, since it involves clients from three years ago, who may not sill be holding the funds affected.

 

Signet (SIG) buying Zales (ZLC): a takeover scorecard

Last week, shareholders of mall jewelry company Zales (ZLC) voted to approve the takeover of the firm by its rival Signet (SIG).  SIG, a UK-listed company owns Kay and the more upscale Jared, as well as a number of (much less interesting, in my view) UK brand names.  The acquisition price is $21 a ZLC share, or about $670 million.

When I was working I liked luxury goods in general and the jewelry business in particular.  My portfolios contained Tiffany (TIF) and SIG more often than not, and Bulgari (now a part of LVMH) from time to time.  ZLC never.

What I’m primarily interested in today is to outline ownership percentages that are important in any US-based takeover.

1.  at 80% ownership, the acquirer can file a consolidated tax return, meaning losses in one part of the company can be used to offset otherwise taxable income in another.  As well, funds can pass freely from one part of the combined company to another without being considered (taxable) dividends.

2.  at 90% ownership, under the law in Delaware (where virtually every publicly traded US company is domiciled) the acquirer can force the other 10% to tender their shares.  Not having a minority interest makes running the combined company much easier administratively.  Specifically, the firm doesn’t have to concern itself with a tiny number of shareholders whose sole aim may be to become enough of a nuisance to be bought out at a higher price.

3.  at 90% ownership, dissenting shareholders do have the right to appeal to the Delaware Court of Chancery.  There, they can argue that they–but not the vast majority who have accepted the takeover offer–deserve a higher price.  Whatever the outcome, they are still compelled to sell their shares.

The process can be time-consuming.  It’s also risky.  The dissenters’ funds are tied up while the appeal is being heard–and if they lose, they’ll end up with the takeover price, less their legal expenses and will get the money maybe two years from now.

4.  SIG and ZLC are in the same industry.  If I understand US tax law correctly (a big “if”), this fact makes the accumulated tax losses of ZLC more readily available to SIG than would normally be the case.  This could be important, since my cursory reading of the ZLC 10-k suggests ZLC lost just under $500 million in the US during 2009-2012.  Those losses would be worth around $140 million to SIG if they could be used immediately, even if ZLC already used some of them in 2009 to recapture earlier taxes paid.

this may well be an interesting chancery court case

Several large institutional owners of ZLC shares have voiced their intention not to tender all/some of their shares to SIG and to seek a higher price in chancery court.  This may simply be bluster.  If not, I think the case will be an interesting one.

SIG has said that it expects to improve ZLC’s operating results by $50 million a year by using the SIG sourcing apparatus and by another $20 million by plugging ZLC into SIG’s administrative structure.  It expects a final $30 million from sales growth and repairs.  Then, of course, there’s that $140 million in potential tax benefits.

What I find interesting is that just about all this extra value is created by the fact that SIG is the new owner.  A private equity buyout, for example, wouldn’t have anything like the same positive effect, since it wouldn’t have the appropriate sourcing and repair infrastructure (I’ve visited the SIG diamond vault, by the way).  And their use of ZLC tax losses would be far more restricted.

Are minorities entitled to share in value being created solely from intellectual any physical property owned by SIG?  If it come to chancery court, the argument should be interesting.