Update on Dell’s proposed LBO

We are writing a short follow up on Dell’s LBO, which we covered on February the 16th.

Following his opposition to the offer of Michael Dell and Silver Lake to take Dell private, Carl Icahn, the former corporate raider turned activist investor (who is also involved in the Herbalife situation we analysed last week), started buying more Dell stock to muscle himself into Dell’s Board of Directors, reaching a stake of approximately 6%. He is proposing to shareholders a leveraged recapitalization where a special cash dividend of $9 per share will be paid to all shareholders.  According to Mr. Icahn, the dividend together with a residual stock value of $13.81 would give shareholders a total value of $22.81 which is a 67% premium over Michael Dell’s offer of $13.65 per share. This is also near the valuation which has been indicated by the largest outside shareholder, Southeastern Asset Management.

Leveraged recapitalizations are financed primarily through debt; they are classical anti-takeover measures for companies facing a hostile takeover. The company pays out a large dividend which is financed through debt and thus the capital structure of the company changes substantially (less equity and more debt) making it less desirable for potential acquirers. Apparently this is what Mr. Icahn is trying to do: he wants to finance a $9 cash dividend by using up Dell’s massive $6bn cash buffer, by factoring existing receivables and through debt. What makes the offer even more intriguing is the fact that Mr. Icahn has offered to provide debt financing of $5.25bn to support this alternative, both from Icahn Enterprises ($2bn) and from him privately ($3.25bn).

Starting from January, Dell shares have increased 27% from a lagging $11 per share to $14.14 per share on Friday. The stock price increased right after news on the buyout was leaked to the media reaching $13.60 per share (close to Michael Dell’s and Silver Lake’s offer of $13.65). It is however now trading at a 3.6% premium, a clear sign that Wall Street is expecting Michael Dell to either offer a higher price or is expecting offers from other investors as Dell is now in a go-shop period. Except for Carl Icahn, who signed a confidentiality agreement with Dell to access the company’s internal books, industrial players such as Lenovo and HP have also been granted access signalling that this LBO is far from closed. Moreover, Blackstone, another private equity player, has signed a confidentiality agreement with Dell as well, enabling them the same access.

We believe that Carl Icahn is trying to drive up the stock price, and make a decent profit on his stake as Michael Dell and Silver Lake will have to increase their bid by a couple of dollars to get the bid offer accepted by the biggest shareholders. This is in line with Icahn`s strategy in several other companies and it is exciting to see the increasing level of activism in the market the last couple of years. We believe that a small increase in the bid will be enough to turn shareholders in favour of the deal, as the company has struggled lately and the share has been depressed, thus not giving full credibility to Icahn’s estimate of a $13.81 residual value per share post a leveraged recap. In our view, the emergence of a serious competing offer from a PE house is less likely, given that the current proposal combines the knowledge of the founder (Michael Dell), a specialist tech PE fund (Silverlake) and has the support of a large tech corporate (Microsoft). While the terms of the deal may change as a result of Icahn’s efforts we also think that a full-fledged leveraged recap or a serious competing offer from another corporate are unlikely.