How a Dell Deal Might Work

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Dell (NASDAQ: DELL), a company that made its name by selling personal computers to the masses, saw its shares climb after Bloomberg reported that founder Michael Dell was in talks to take the company private. Mr. Dell, who owns about 15% of the company, was said to be talking to private equity (PE) interests to pursue a buyout.

It usually pays to be skeptical when one hears these rumors and it should be assumed that a deal is probably not going to happen. But to accurately assess the probabilities of a transaction and its potential valuation, a couple of questions need to be answered.

1. Is a Dell deal possible?

To assess the possibility of a PE buyout we need to look at a deal structure scenario. One scenario is a $16 per share bid and it might look something like this:

Michael Dell would exchange his current 15% stake for a 20% stake in the private company. There would be a $16 bid for the remaining 85% shares outstanding costing roughly $23.8 billion. The company would fund $5.0 billion out of cash on hand and fund another $5 billion by leveraging up its balance sheet with additional debt.

Though most PE buyouts would try to increase the borrowed portion of the buyout funding, I’m not sure Dell has a compelling story that would sell the bankers on a significantly higher debt amount. Frankly, $5 billion might even be a stretch.

But assuming that the $5 billion in debt can be raised, that would leave $13.8 billion to be funded by PE. Given Dell’s limited breakup potential, questionable growth outlook, and murky exit strategy, it seems unlikely that even a consortium of firms would be willing to burden that much of a commitment.

So does that kill a possible deal? Not necessarily.

Dell does have an attractive attribute that may be enticing to another tech company who could join in a buyout deal. Dell has a substantial corporate enterprise business. One can remember that when the personal computer was launched, though the initial interest was in consumer acceptance, it was corporate adoption where the real money was made. Dell’s meaningful position in the corporate computing world could be very attractive to a company looking to expand or solidify its business in that critical market.

In the $16 per share scenario, with a remaining $13.8 billion to be funded, if another tech entity would invest $7 billion for a 29% stake in the deal, that leaves $6.8 billion for PE to add. Though better, the odds are still not good for such a large amount.

But changing the scenario to a $14 per share bid, a buyout looks doable. Here, Michael Dell would exchange for a 20% stake with $5 billion of funding coming from company cash and $5 from additional debt. That would leave roughly $10.9 billion to be found. If an interested corporate player takes 29% for $7 billion, that leaves PE on the hook for $3.9 billion.

While the $3.9 billion is still probably too much for one house to shoulder, a pooled deal with two or three firms might be possible.

This deal structure may also be a win-win for both corporate player and PE firm. With a possible buyout clause where the corporate partner pays $8 billion in a few years if things go well, the PE can have an appealing exit strategy and double their investment. The corporate player would also get 80% control of an attractive entity for the decent price of $15 billion and take a lot less risk than via an outright purchase.

2. Is a Dell deal likely?

The simple answer is no. When talking about such big numbers and so many players the chances of a deal happening are not going to be good. But the actual likelihood seems to depend on the availability and willingness of a corporate partner.

There are some candidates that have the means and could have an inclination to enter such a deal.

Oracle (NYSE: ORCL) looks like it can fund the $7 billion. Its founder and CEO, Larry Ellison, might also find it attractive to continue his clash with rival Hewlett- Packard by furthering his corporate enterprise business with a Dell hookup.

Microsoft (NASDAQ: MSFT) clearly has the financial ability to enter a deal. The company is already experimenting with computing hardware and its dependence on the corporate enterprise business might be strengthened with the addition of Dell distribution.

Google (NASDAQ: GOOG) doesn’t seem like a natural fit, but it is also in the initial stages of offering mobile computing hardware. It may find Dell’s business an opportune way to expand its hardware and operating & application software to a wider audience. Google also seems capable of funding its part in such a buyout.

There are also foreign firms who may find an initial minority stake in Dell attractive. Companies such as Samsung, HTC, Huawei, and even Lenovo might find the deal appealing as a way to meet U.S. corporate IT needs as well as being more agreeable to US regulators.

Given the factors, a Dell deal still doesn’t look likely. A private equity buyout may not even be possible. But a pooled deal between private equity and an interested corporate player somewhere in the $14 a share range could be doable. However it goes, it will certainly be interesting to see how this story plays out.

grahamsway (Bob Chandler) has a long position in Dell. The Motley Fool recommends Google. The Motley Fool owns shares of Google, Microsoft, and Oracle.. 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!

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