Michael Dell or Carl Icahn?
Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Carl Icahn is currently the wealthiest man on Wall Street. Ranked 21st on the Forbes 400 list, this man is a lion of an investor. He has a history of successfully managing funds, hostile takeover attempts, and has taken on an activist role in companies that investors were not anticipating. Carl Icahn hasn't released a complete set of details for how the transaction with Dell (NASDAQ: DELL) will go through, as it has been often noted in the media. So at best, what we're doing is a bit of speculation using known facts.
The deal can go through
What we do know about the proposed transaction comes from Southeastern Asset Management. Southeastern Asset Management built a break-down analysis of the special dividend (a one-time dividend payment that's extraordinarily large). The special dividend will require Dell to borrow $9 billion in cash from an outside source, and use that cash for a special one-time dividend. The desired outcome is that the company can repay the additional $9 billion in debt over time.
Source: Southeastern Asset Management
Carl Icahn (Mr. Miracle Worker) was able to convince Jefferies & Co to lend $5.2 billion through a term loan (the two loans were a B-1 and B-2, which are non-traditional below-investment-grade loans, but that have an established rating), got an added $1.6 billion commitment from his own investment bank, and included $2 billion of his own capital, for a total of $8.8 billion, which is close enough to the $9 billion that was needed for the special dividend to become a reality. So, through the contribution of $9 billion in debt, spinning off of Dell Financial Services for $3.1 billion, and using the $9 billion in cash on the balance sheet, the company is able to issue a $21.35 billion dividend. This will result in the $11.86 one-time dividend.
The basic assumption, which I highlighted in more detail in a previous article, is that the dividend and the stock combined could be worth more than the $13.65 offered by Michael Dell. Assuming that, if Dell issued an $11.86 dividend, there’s a high probably that the stock would trade above $1.50 per share, which would imply that investors could earn a substantially higher return by voting on Carl Icahn’s proposal.
Southeastern Asset Management and Carl Icahn own a large percentage of the company. Based on the institutional interest of the two, the vote could heavily favor the special one-time dividend.
The house of cards
We can’t forget that Carl Icahn currently has many other things going on as well. The billionaire’s most lucrative investment has been Netflix (NASDAQ: NFLX). I share the billionaire’s optimism in the business. The company is well-positioned to grow, and its global subscriber base is its fastest-growing asset. Its ever-expanding content collection (through deals with Time Warner, Walt Disney, and DreamWorks Animation) gives it a competitive advantage. The company is well-positioned as the number of web-capable devices will grow from 10 billion to 30 billion by 2020. Netflix only needs to capture a small fraction of that ever-expanding pool of devices in order to substantially grow earnings. At $8 per month, the company's service is competitive in almost any country.
To be fair, the company only provides guidance up to one quarter out, so, if anything, these projections are either overly conservative or overly optimistic. On a consensus basis, analysts expect the company to grow earnings by 386.20% in fiscal year 2013. But, based on the company’s recent earnings releases, paired with the company’s willingness to lower some expenses, Netflix could very well surprise analyst estimates going into the end of the year.
Herbalife isn’t a dead pyramid yet
While I understand the criticism toward pyramid schemes, it seems that Herbalife (NYSE: HLF) may not necessarily fit the criteria for one, based on the strictly academic definition of a pyramid scheme.
Based on my research, I find it highly improbable that the company will reach the decline phase of its growth phase. Based on historical analysis, it could take 10, or even 20, more years for the company to report a year-over-year decline in net income. If that is the case, then there’s too much risk for shareholders to join the short on the stock with Bill Ackman. There’s a low probability that the company will actually be considered a pyramid scheme by the FTC, and that’s exactly what's needed for the stock to crash. If the stock doesn’t crash, there’s no way a short position will make any money.
Most likely, Carl Icahn bought the stock because he tends to find value where no one is looking. The company is well on its way to sustaining earnings growth over the next two years. Analysts anticipate the company will grow earnings by 18% for the 2013 fiscal year, and 15.13% in the 2014 fiscal year. The company trades at a 10 earnings multiple, which implies that the company is heavily undervalued. The stock compensates investors with a 2.64% dividend yield.
I think there’s a high probability that Dell shareholders will vote in favor of Icahn's special dividend proposal. Icahn's position in Netflix will pay off, based on the company's projected earnings growth and untapped market potential for movie streaming. I am also dubious of Bill Ackman’s claims that Herbalife is a pyramid scheme. It could take decades before the company ever reports a loss, and by then, the whale of a short position that Bill Ackman has on the stock would have lost a lot of money.
I believe that Dell has the most short-term upside, as there's an attractive arbitrage opportunity that could result in substantial short-term yields. Following that, Netflix has the most potential in terms of long-term appreciation. Finally, Herbalife is undervalued as an investment, relative to its projected growth, making it the third best of the three.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix and has the following options: Long Jan 2014 $50 Calls on Herbalife Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!