Details on the recently announced Dell LBO are interesting.
First the deal is creditworthy. Michael Dell ($4.50B) and Silver Lake (1.4B) are
investing almost $6B in equity thru rollover and new equity. This is
supplemented by junior capital of $4B provided $2B each by Microsoft and de
facto subordinated existing bondholders. The remaining $15, or so, of new bank
provided senior debt will be supported by a strong 40% junior capital position.
Add to this excess cash of over $7B being repatriated from overseas at a
substantial tax penalty, and projected
annual $3B of cash flow, albeit declining, should comfortably cover annual debt
service. Estimated credit ratings in the BB range reflect these facts.
Just because something can be done does not mean it should
be done. Something still does not make sense. The transaction is justified as
accelerating the transition from PCs to services by removing Dell from the
distracting spotlight of the short term public market. The question is how? The
increased debt, while supportable, reduces flexibility. Debt service
requirements, unlike discretionary dividends and share repurchases, combined
with new debt covenants will hamper Dell’s transition strategy implementation-especially
if something goes wrong and new investments are needed. This is a key concern
as Dell faces deep pocket investment grade competitors like IBM as it
repositions itself. Already, HP has announced they will go after Dell’s PC
customer given Dell’s increased financial vulnerability.
Next, and perhaps most importantly for Dell’s existing
shareholders, the Dell investor group has yet to disclose what it will do differently,
and more successfully, as a private firm than it has done as a public firm. Dell
has been trying for years to reposition itself all with mixed results. This is
the reason for Dell’s sagging share price. The market may not be short sighted
as much as it is skeptical, given existing performance. So what is different once
Dell goes private? Is there some secret sauce that has yet to be disclosed, and
if so, why has it not yet been disclosed? If they have a new secret and
credible, turnaround sauce, then disclose it and the market will reward the
firm with a higher valuation. Of course, under that approach, Michael Dell and
his investor group have to share the upside with existing shareholders instead
of capturing all of it for themselves.
Could it be the investor group is planning to immediately
dispose of the ailing PC business? Another possibility could be a planned
special dividend to the investor group after the deal closes using some or all
of the repatriated cash. This would effectively reduce the investor group’s
investment basis thereby giving them a free upside option. Perhaps, there is a good reason for the
shareholder class action suits filed upon the LBO announcement.
Perhaps, I am just a confused skeptic. Alternatively, I
smell a rat. Given Michael Dell past actions, when he is buying, you do not
want to be selling. So for existing shareholders, the Dell LBO may indeed mean
lookout below.
Your confused skeptic -Joe
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