Part 2 of our discussion of using multiples in valuation will appear Wednesday. We wanted to get this timely post on Dell out today.
R
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The potential Dell
LBO continues to develop. Microsoft is considering a $3B convertible preferred
stock investment. This would greatly strengthen the outlook
for the transaction. Besides improving the capital structure, it provides a
deep-pocket strategic partner. This is crucial to provide comfort to debt
providers as a secondary repayment source should Dell experience financial
problems.
Microsoft has a strong interest in seeing Dell, a major customer,
survive. An out-right Dell purchase might pose concerns with some of
Microsoft's existing suppliers and Window's allies. The joint venture with Silver
Lake, the lead PE firm, provides a toehold investment with the implicit option
for an additional follow-on acquisition. Should Dell falter, then Microsoft
could elect to support Dell by increasing its ownership under the cover of
protecting its investment. If Dell prospers, then Microsoft could serve as a
strategic exit partner. Bottom line, they obtain an inexpensive option for
a subsequent acquisition, reduce initial supplier and allies concerns and avoid
having to consolidate Dell on its balance sheet.
Next to consider is the value transfer from Dell's bondholders to the
transaction. Like most investment grade bondholders, Dell is currently rated
A2/A- by Moody’s and S&P respectively. Dell's bondholders have minimal covenant protection and cannot force Dell to repay them once Dell goes private. Thus, Dell avoids having to refund the low rate bonds with more expensive buyout debt. The existing bondholders continue to receive an investment grade
coupon on their investment, which is now non-investment grade-most likely
BB post close. Worse yet, the bonds will become effectively subordinate to the
buyout debt. Consequently it comes as no surprise that Dell's bonds have
plunged in price since the LBO discussions began.
I still question the wisdom of a highly leveraged Dell trying to
adjust to its strategic challenges in a maturing and highly competitive
industry facing substantial competitors who are unburdened by high leverage.
Nonetheless, the potential for financial engineering related magic may just
make the transaction possible even if it remains unwise. The Dell Silver Lake
guys are good.
More to follow I am sure.
J
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