Icahn’s Proposal Could Help Dell Shareholders

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Dell (NASDAQ: DELL) shareholders have an interesting choice to make. They can either accept the terms of management's current $13.65 per share leveraged buyout (LBO) offer or vote against the buyout and hope that the company's operations will stabilize and that executives might take some sort of shareholder friendly action.

However, famed value investor Carl Icahn recently offered another option. In a letter to Dell directors, he proposes a recapitalization of the company through a large one time $9 per share special dividend funded by $7.4 billion of available cash and roughly $8.3 billion in additional debt if the LBO is not successful. This suggestion may alter the dynamics of the buyout significantly and in the favor of most shareholders.

Icahn's ability to provide shareholder value has to be taken very seriously. A good example is his experience with vehicle and construction equipment maker Oshkosh (NYSE: OSK). After obtaining a 9.5% stake in 2011, he battled the company through proxy fights and a $32 per share bid to take the firm private. Though unsuccessful in his attempts to gain Board of Director representation, his efforts persuaded management to improve operations and the share price rose from around $20 in 2012 to over $40 in 2013.

In reviewing possible Dell scenario's, it seems that a value increase may also be achievable in this case. Here's how the alternatives look:

Scenario 1: Management's LBO Offer At Current Operations

The current $13.65 per share tender does not seem a great deal if one assumes that operating results can be stabilized, which is probably a fair conjecture given management’s desire to buy the company. (I spell out some other reasons the transaction might not be so good in this earlier post.)

In calculating Dell’s fair business value, or cash earnings multiplied by a capitalization factor, using an annualized estimate of the company's third quarter 2012 report looks like a reasonable as-is baseline. In this case, the company would generate roughly $54.9 billion in yearly sales and $1.9 billion in adjusted cash earnings. Its fair value, using a 10 to 12 multiple, would then come in between $11 and $13 per share.

Under this scenario, shareholders are offered a roughly 14% premium to fair value, but also relinquish any possibility of upside due to business improvement or shareholder friendly action.

Scenario 2: Current Operations With Shareholder Friendly Action

There does seem to be evidence that shareholder value would increase with relatively minor board action. Assuming that operations are stabilized at the same $54.9 billion in sales and $1.9 billion in earnings as in the first scenario, a share buyback could add meaningfully to per share worth.

If the company undertakes a share buyback, utilizing Mr. Icahn's projected $7.4 billion in available cash at a share price of roughly $15, the number of shares outstanding would drop to around 1.24 billion from 1.74 billion. The resulting fair value per share would increase to between $15 to $18 using the 10 to 12 multiple range and after adjusting for the income lost in using the cash.

It looks like the shareholder friendly act of using available cash for a share buyback could offer about a 17% premium to the current LBO bid.

Scenario 3: Icahn's Recapitalization Proposal

This scenario may offer the most compelling possibility for increased shareholder value.

Starting with the baseline-operating expectation of $54.9 billion in revenue and $1.9 billion in cash earnings, we need to adjust for additional debt cost and loss of income from the use of cash-on-hand due to the special dividend. Assuming an additional pre-tax debt cost of roughly $378 million and pre-tax cash income loss of $148 million, adjusted earnings would be reduced to around $1.6 billion. This would equate to a fair value of around $9 to $11 per share assuming a 10 to 12 multiple and 1.74 billion in outstanding shares.

The total valuation, adding in the proposed $9 a share special dividend, looks to be about a 39% premium to the current offer or a fair value of $18 to $20 per share.

Conclusion

It seems investors have an interesting choice when contemplating Dell's buyout offer. There does seem to be evidence that with at least some shareholder friendly effort by the board, the share price could be noticeably higher than the $13.65 bid.

IBM (NYSE: IBM), the well-known computer equipment and service company, is a good example of the good things that can happen when a firm works for all shareholders and implements a successful turnaround. IBM stock, near a 52-week high, currently sells at around a 15 multiple on revenue of $104.5 billion with cash earnings of $15.4 billion. The interesting thing is that the company sells at this elevated multiple even with 2012 revenue declining about 2% and only a 4% income increase. The market's positive sentiment might have a lot to do with the company's willingness to consistently benefit shareholders. IBM has spent large amounts repurchasing shares, expending $12 billion in 2012 and $15 billion in both 2011 and 2010.

Mr. Icahn's proposal, coming from a well-respected investor with a history of creating value, now seems to offer shareholders another option for possible significant value realization. While it is still not clear how this will all play out, his quantitatively precise suggestion can only increase the odds that investors will get a fair result.


Bob Chandler has a short position in Oshkosh. 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!

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