Dell Buyout at $13.65 Not Guaranteed
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Carl Icahn seems to be at it again, but this time, the man seems to have more of a practical strategy. With the financing issue settled, the Dell (NASDAQ: DELL) board of directors found the special dividend proposal to be largely unappealing. So the Dell board is telling investors to vote in favor of Michael Dell’s proposal of taking the company private at $13.65.
The details of the new deal
The details surrounding the deal are leery at best. But it seems that Carl Icahn is offering a proposal whereby Dell will implement a share buyback of 1.1 billion shares for $14 per share. Source of capital for the share buyback will come from various entities. Icahn Enterprises (NASDAQ: IEP) will be investing $1 billion directly into Dell, and Carl Icahn himself will invest $1 billion directly into the company. An added $5.2 billion will come from a term loan provided by Jefferies & Co. In order to sweeten the deal, Carl Icahn is also proposing a stock warrant at $20 per share.
Currently Dell has 1.8 billion shares outstanding. So the share buyback would reduce the shares outstanding by more than half. This would cause the share float to significantly decline, and would result in a significant improvement in per-share metrics like earnings per share. The hoped for outcome is that through the company buying back its own shares at $14 per share, it can induce a stock rally that could push the value of the stock above $20 per share.
Analysts project that the company will generate $1 in earnings per share, which basically translates into $1.8 billion in net income for the 2014 fiscal year ending on January. The share buyback would basically reduce the total shares outstanding down to 700 million shares, which should inflate earnings to $2.57 per share assuming earnings don’t decline more than anticipated for the current fiscal year. The company in its history has never been able to report earnings of $2.57 per share; the highest the company has ever gotten was $1.50 in earnings per share back in 2005.
Downside and upsides to the deal
If earnings were to come in at $1.8 billion for the fiscal year, and the board implements the share buyback proposal, the stock could have significant upside. The share buyback would reduce the total supply of shares, which will increase the value of the shares.
The downside is that Dell will have to borrow money in order to finance this share buyback program. The added cost of interest will lower the projected net income for the 2014 fiscal year ending in January. The upside is that the share buyback may force the stock above $20 per share, and will allow Dell warrant holders to reach breakeven. Details on the ratio of stocks per warrant are unknown. However, in the event the stock trades above $20 the exercising of stock warrants will increase the share float.
The added leverage will reduce the soundness of the balance sheet. On the bright side, there are pent-up upside catalysts: desktop and laptop computers will eventually recover in 2014 because Microsoft will no longer support Windows XP. This could force a product refresh in 2014, and cause earnings to grow significantly. Based on those outward looking assumptions analysts are willing to forecast 24% earnings growth in the next fiscal year.
Those who currently own Dell stock cannot lose. The stock currently trades at $13.14 per share. The stock will either be bought out at $13.65 per share, or experience significant upside from Carl Icahn’s share buyback proposal.
My take on the PC industry
Dell is more of a special scenario whereas Hewlett-Packard (NYSE: HPQ) is not. Sound fundamentals like better cost management and potential product refreshes would better apply in this instance.
Hewlett-Packard may be able to sustain its growth by offering tablet devices in emerging markets. The company currently markets the HP Slate 7, which runs on Android 4.1 Jelly Bean. The device is aimed at lower-end markets (which also means it runs on lower-end components), with prices starting at $139.
The problem with the low-end devices is the low gross margins offered by the devices. On the upside, macroeconomic indicators largely support the need to offer low-end devices. Procter & Gamble estimates that between 2010 and 2020 the middle class will increase by 1.4 billion (98% of this will come from emerging markets).
The extensive retail distribution in foreign markets paired with the extreme low-end Android tablet could result in substantial market share gains for Hewlett-Packard. The effects on profitability are debatable. But Meg Whitman believes that the company is on schedule when it comes to restructuring and will be working down non-labor costs in 2014 or 2015.
Analysts aren’t offering any long-term forecasts that are likely to reflect reality. So at best, our growth estimates would be driven by falling costs, paired with revenue growth in tablet devices, offset by PC shipment declines in 2013. In 2014 PC shipments should improve due to a product refresh, growth in tablets, and falling non-labor costs. Hewlett-Packard doesn’t provide any long-run guidance. So my best guess is a modest year-over-year decline in net income in 2013, with significant surprises in 2014.
Of the opportunities presented in the computer space, Dell seems the most practical in terms of potential investment returns over the short-term. However, investors that are more focused on the long-term should also consider investing in Hewlett-Packard.
I think that Carl Icahn’s most recent proposal seems to have the most potential to maximize investment returns. However, in the event shareholders go with the buyout at $13.65, the stock currently trades at $13.14, so investors would not lose money in either scenario.
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