DELL; Market Cap: N.A.
EMC; Market Cap: $53.49bn (as of 16/10/2015)
VMware; Market Cap: $28.76bn (as of 16/10/2015)



On October 12, Dell, one of the largest technological corporations in the world, agreed to acquire EMC Corporation, the world’s largest provider of data storage systems by market share. This $67bn deal is set to create a tech powerhouse, and is going to represent the biggest deal in tech history.


About Dell

Dell, headquartered in Round Rock, Texas (US), is a computer technology company, which was taken private in a $24.4bn leveraged buyout backed by Silver Lake Partners in 2013. The company sells personal computers, servers, data storage devices, software, cameras, printers, MP3 players and electronics built by other manufacturers. Dell is well known for its direct-sales model and “build-to-order” approach to manufacturing, which allowed consumers to build their machines online and then get them delivered to the front door.

Dell was a pure hardware vendor until 2009, when it entered the market for IT services with the acquisition of Perot Systems, an information technology services provider. Since then the company made additional acquisitions in storage and networking systems, with the aim of expanding its portfolio from offering computers only to delivering complete solutions for enterprise customers.

About EMC

EMC Corporation (NYSE: EMC), headquartered in Hopkinton, Massachusetts (US), is a global leader in enabling businesses to transform their operations and deliver IT operations as a service. Through innovative products and services, EMC accelerates the journey to cloud computing, helping IT departments to store, manage, protect and analyse information in a more cost-efficient way. The company sells data storage, information security, virtualization, analytics, cloud computing and other products and services. EMC is characterized by a “federation” structure, which allows ECM to operate through a handful of semi-independent businesses – EMC Information Infrastructure, VMware Virtual Infrastructure and Pivotal.

About VMware

VMware (NYSE:VMW) is a California-based software maker. The company provides cloud and virtualization software and services. In 2004 EMS acquired VMware for $635m and then spun off a 15% stake in 2007. As of last week, the business carried a market value of more than $34bn, ranking it among the biggest corporate investment returns in tech history.

Industry Overview

Consolidation is the main solution for companies, which are faced with a shrinking market.

In fact, the merger between the two complementary companies – Dell and EMC – would allow the tech giant to get a larger slice of a smaller pie. According to Mr. Dell, the new company would consist of strategically aligned businesses, which will enable an increase in innovation, customer choice and the ability to attract and retain world-class talent. However, Dell is actually pursuing an opposite strategy to the one spreading through the tech industry lately, which is demerger activity. In fact, Dell’s rival HP will spin-off its PC and Printer businesses from the rest of the group in November. Nevertheless, Mr. Dell argues that sticking to the one-stop shop business model would help it draw corporate customers eager to buy servers.

The news about the companies’ merger put the rest of the storage market in the spotlight. For instance, the shares of Pure Storage, maker of newer flash-based storage systems, enjoyed a 20% bounce.

Deal Structure

Dell’s mega acquisition of EMC, which will create the world’s largest privately held integrated technology company, comes with a valuation of $67bn and a distinctive financial structure. Dell agreed to pay each EMC shareholder $24.05 a share in cash while the remainder will be paid via a new security – tracking stock – linked to a portion of EMC’s interest in VMware, a separately-traded virtualization company (NYSE:VMW). This remainder, or the so-called non-cash portion of the take-over price per share, will be valued at 0.111 of VMware tracking shares. Therefore, all in all, each EMC share is valued at $33.15, considering the intraday volume-weighted average price for VMware on Wednesday, October 7. As such, deal valuation is dependent on VMware share price and has declined over the last week following VMware share price drop (see later market reaction).

By acquiring EMC, Dell will indirectly acquire all of the common shares of VMware owned by EMC, approximately 343m shares corresponding to 81% of the outstanding common shares of VMware. Assuming no change to EMC’s percentage ownership of VMware, the tracking stocks issued at closing of the transaction will track the performance of an approximately 53% economic interest in the VMware business. Dell’s remaining 28% economic interest in the VMware business will not be subject to the tracking stock and will be for the benefit of Dell’s other common stockholders. The closing of the transaction will not change the ownership of VMware Class A common stock owned by public shareholders of VMware (which currently amounts to approximately 19% of the outstanding common shares of VMware) or the total number of VMware common shares outstanding at closing.

This complex structure gives rise to some interesting considerations that will be addressed below.


What is a tracking stock?

Tracking stock will be a class of common stock (“Class V Common Stock”) issued by the parent company (“Denali”) of Dell and EMC. Tracking stock is intended to track the performance of a portion of Denali’s economic interest in VMware. At closing, Denali will issue approximately 223m shares of Class V Common Stock with an initial one-to-one relationship with VMware common shares.

Why is Dell using it?

There are competing arguments regarding the reason why Dell is implementing this complex structure. At the basis is the constraint on the amount of cash financing available for the transaction. Basically, the issuance of the tracking stock enables Dell to pay a higher purchase price for EMC than it could in a transaction consisting of 100% cash consideration. But still, why is Dell not giving up the entire VMware stake to EMC shareholders, thus lowering the amount of the deal, rather than keeping control of the company? There are two potential conjectures that go in the opposite direction.

One explanation may be that Dell is not interested in VMware, but needs to acquire it as part of the EMC deal and is therefore trying to acquire as little as possible of it. In support of this theory there are some thoughts regarding the limited synergies of VMware operations with Dell and EMC. Hence, it would make more sense for Dell to buy EMC and spin off VMware. However, the tax bill emerging form this transaction would be prohibitively expensive, c. $8bn, given the capital appreciation of VMware – EMC bought it for $635m in 2004 and the current valuation amounts to c. $24bn. Hence, the tracking stock compromise allows a partial spin-off without any tax impact.

Another opposing argument, sustained by Dell itself, is grounded on the assumption that EMC’s interest in the VMware business is a fundamental part of Denali’s strategic rationale for this transaction. Thus, the tracking stock allows Dell to retain control of VMware in a relatively “cheap” way and gives the shareholders of EMC the opportunity to benefit from any value creation from the expected revenue synergies with Dell.

And so… Is Dell going public again?

In a way it is.

Tracking stock is just a new class of stock issued by the company. Hence, after the close of the transaction, Denali will become a SEC registered company. Denali filings will include 10-Ks and 10-Qs, which will include consolidated financials and segment information with financial results for VMware business segment. In addition, VMware will remain a public company and will continue to report annual and quarterly financials. However, holders of the tracking stock will be entitled neither to voting rights on VMware nor to Denali’s earnings. More importantly, the tracking stock is not even an interest in VMware stock, but instead in Dell with the only rights to the proceeds of any sale of VMware shares or any dividends paid on VMware shares.

Yet, being a Denali’s common share, holders of tracking stocks will have some voting power on Denali itself. Indeed, even if Denali is a closely held company, the Class V Common Stock will generally vote together with Denali’s other classes of common stock as a single class in the election of three independent directors of Denali and on all other matters presented to a vote of Denali’s common stockholders. Nevertheless, the common shares owned by Mr. Dell, MSD Capital and Silver Lake Partners will have 10 votes per share and the Class V Common Stock will have only 1 vote per share, resulting in the Class V Common Stock shareholders having as little as 4% of the total votes at Denali.

Deal Financing

Truth is that out of the $67bn of the deal, Dell’s shareholders will only contribute with $4bn of equity. Indeed, the tracking stocks will contribute for c. $15bn of financing. The remaining portion of cash will be debt. According to people familiar with the deal, Dell will raise c. $48bn in debt: about $10bn of that is expected to be bank loans and additional $3bn in a revolver, about $10bn raised through the high-yield market, $8bn committed by institutional shareholders and $17bn in high-grade bonds.

The new company is expected to have $56bn in debt after closing. Considering that EMC is expected to generate $6.3bn in EBITDA and adding the $4.5bn Dell 2013 EBITDA (Dell hasn’t released earnings numbers since it went private in 2013, but there is some indication that Dell’s cash flow has slipped since then) we obtain a leverage ratio (Debt/EBITDA) of c. 5.1x. The level is not totally unreasonable for a leveraged deal; however large tech deals tend to have less debt – the recent $36.5bn takeover of Avago Technologies, announced earlier this year, had leverage ratio of c. 3.2x.

However, according to Dell’s management, given the strong track records of cash flow generation and debt reduction by both EMC and Dell itself, the transaction is expected to have a neutral to positive impact on Dell’s current corporate credit ratings. Moreover, the combined company will focus on rapidly de-levering in the first 18 to 24 months following the closing of the transaction, and on achieving and maintaining investment grade debt ratings. S&P affirmed its BB+ credit rating on Dell, upon expectations that the company will be able to hit its cost savings targets and bring debt down to comfortable levels within a year.

Market Reaction

After the announcement on October 12, EMC shares reacted positively with a 1.8% increase to $28.35, a significant discount to the c. $33.15 bid per share. On the contrary, VMware share dropped 8.1% to $72.27, probably reflecting the fact that it will be left on the public markets rather than bought at a premium and due to the expected dilution coming from millions of new shares flooding the market. Moreover, market participants are expecting the tracking stocks to trade at a discount with respect to VMware common stocks given the absence of voting rights.

Closing and “Go-Shop” Option

The transaction is subject to customary conditions, including receipt of required regulatory and EMC stockholder approvals and it is expected to close within October 2016.

As part of the deal, there are rumours that EMC will have up to 60 days to seek a better offer from other potential suitors. The company will have to pay about $2bn before the expiry of the 60-day ‘go-shop’ period, during which EMC can solicit other bids and $2.5bn after the expiry on December 12. Among potential bidders there are Hewlett-Packard and Cisco Systems; however markets do not seem to anticipate a rash of enquiries. HP did speak to EMC a year ago, but its market capitalization today is only $53bn, slightly less than EMC’s. Moreover, it is about to split in two whereby the new HP Enterprise company will have even less clout to get in the way. Cisco instead has a new CEO, who would be making a huge bet.

Financial Advisors

Morgan Stanley is acting as lead financial advisor to EMC. J.P. Morgan is acting as lead financial advisor to Dell and Silver Lake. Credit Suisse and J.P. Morgan are acting as global financing coordinators. Barclays, Bank of America Merrill Lynch, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, J.P. Morgan and RBC Capital Markets are providing debt financing to Dell.

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