Monday, January 28, 2013

Dell LBO: The Beat Goes On

Part 2 of our discussion of using multiples in valuation will appear Wednesday.  We wanted to get this timely post on Dell out today.



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.


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