Who Wins in the Dell Deal?
Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It looks like the anticipated Dell (NASDAQ: DELL) buyout has finally been realized. Very few details on the $24.4 billion takeover were reported, but it seems that the $13.65 per share leveraged buyout (LBO) will be mostly financed with roughly $11 billion in loans from a consortium of banks. Other participants include private equity firm Silver Lake Management investing $1 billion, software company Microsoft lending $2 billion, and the rest coming from CEO Michael Dell's equity stake with some cash from Mr. Dell and the company coffers.
Are there any winners in this deal? Not many, but there could be some major losers, including:
Dell, the company itself, may end up being a big loser.
The idea seems to be that privately held, Dell will have the time and flexibility to transform without the spotlight inflicted upon a publicly traded company. But being in the public eye might be less of a handicap than the high debt load this buyout entails.
The $11 billion in bank funding will likely need to be refinanced with relatively high cost public debt. The interest expense on this additional debt might cost around $500 million a year. The company will probably also have to anticipate a "sinking fund," or debt payback pool, of roughly $700 million a year based on a 15-year maturity. The combined requirement could equate to a meaningful 48% of the company's expected cash flow of roughly $2.5 billion.
Though Dell can probably handle the extra expense, it should restrict their ability to make the strategic moves needed to turn the company around. Meaningful acquisitions and investments, all part of their stated plan to revamp, can’t be made easier with a more than doubling of their debt burden.
Dell could also have more difficulty contending with larger well-capitalized competitors as it tries to transform its business.
IBM (NYSE: IBM), the computing giant, reported a 10% rise in operating income for its last quarter and a 13% increase for all of 2012. The company currently has a debt-to-sales ratio of roughly 32% and spends about 6% of their revenues on research and development (R&D), an important investment. On the other hand, Dell will end up having debt-to-sales of close to 36% and even before the deal they only spend about 1.8% of revenues on R&D.
Hewlett-Packard (NYSE: HPQ), a direct competitor, has its own troubles trying to offset the declining PC market. But compared to Dell, it may have the financial upper hand with a debt level of around 24% to sales at the same time investing 2.8% of revenues back into R&D.
The bondholders certainly cannot be happy with this deal. After lending the company money in good faith, they now find themselves in a difficult position.
Facing the deterioration of Dell's credit quality and an underwater coupon rate due to the LBO, one choice they have is to take their lumps, sell out and try to find a decent place to reinvest. The other choice is that they can hold on, keep clipping their weak coupon and hope that things don't go badly. Neither option would seem to be very appealing to an investor class that prefers a stable operating environment with fixed returns.
It doesn't look like most shareholders will be winners. Though the company touts the deal as beneficial, that claim is dubious.
The $13.65 per share offer is about 25% higher than the $11 market price prior to deal rumors, but it seems to offer little premium to the $12 a share price traded in July 2012. It is also a hefty discount from the roughly $17 average market price from January 2011 to March 2012. Given that the $11 price in January 2013 was coming off the $9 low set in November, one might also suppose the price would be around $13 anyway if the company could have offered any positive news.
While lucky enough to receive a nice short-term gain, I still don't consider myself a big winner. When I did my value calculation, I figured that the shares could see between $14 and $17 if Dell showed any sign of stabilizing results. If the company could actually improve operations there should've been further upside.
Claiming that this deal benefits shareholders seems a bit disingenuous. In my pre-purchase analysis, I considered the possibility, but in no way expected, that Dell could have really served the owners of the company by declaring a special dividend of $1.50 a share and a buyback of 40 million shares costing roughly $3 billion. I guess those funds are now assisting the close of the LBO deal.
Are there any winners? Only a few stand out.
The banks should do well. I would be very surprised if their financing offer extended for a meaningful period of time. This means that nice financing fees and interest payments should provide them with a pleasant and quick reward.
Silver Lake and Michael Dell may end up the big winners. It looks like for about $4 billion in cash they get 100% of the equity. With the first grab on free cash flow via dividends and all the upside from restricting any further deterioration of the business, it looks like they have little to lose and plenty to gain.
Is the Dell deal another case where insiders and financiers make big money at the expense of the investor? I don't know. We'll have to wait and see, but it looks like there could be significantly more losers than winners resulting from this transaction.
grahamsway (Bob Chandler) has no position in any stocks mentioned. The Motley Fool owns shares of International Business Machines.. 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!