Since news broke about a potential LBO (leveraged buyout), shares of Dell (DELL) are up about 22%. The possible acquirers, private equity firms TPG and Silver Lake Partners, are said to be in "advanced talks," with Bank of America (BAC), RBC, Barclays (BCS), and Credit Suisse (CS).
Many skeptics have voiced their bearish opinions in the aftermath of the news, and their theses can be summed up as follows:
- The deal would be one of the largest leveraged buyouts in history, so it probably won't happen.
- This sort of transaction will make it more difficult for Dell to make the successful transition to an enterprise solutions company, so the deal won't get done.
- Dell's earnings are in a "free-fall," and thus taking on leverage as a private company would make the firm unstable.
While it's not going to be clean or easy, I think this deal will ultimately get done. That being said, getting long the common stock at current prices may not be the best investment if you're trying to play arbitrageur. Given my past analyses (here and here), longer-term investors have plenty to look forward to even if the deal doesn't close, though initiating a position now should be hedged with an options selling strategy.
The following is my attempt at deconstructing each major bear case :
The deal would be one of the largest LBOs in history: In and of itself, this means nothing. There have been at least 15 private equity above $15 billion in the last decade alone; Business Insider ranked the top 15 in 2011. There have been larger deals that have closed, in interest rate environments that are far less conducive to LBOs than the one we have today. Junk bonds are trading at record highs, there is a ton of capital looking for yield, and the economy is improving. The rumor seems to be that Dell will need to issue almost $15 billion in bonds; I find that totally plausible in today's unprecedented ZIRP economy, and it could probably be done at a reasonable interest rate.
It will make the transition too difficult: I don't quite see why going private would make the transition difficult. Of course, without the "currency" of its own shares, Dell will have to issue more debt or use its cash hoard to make more acquisitions. At face value, that's a fair point, but Dell has mostly been using cash for its biggest deals since issuing undervalued stock to acquire companies doesn't make much sense. Being able to execute its long-term strategy without shareholder scrutiny and stock downgrades might make the process much smoother.
Earnings are in a "free-fall," and this transaction would destabilize the balance sheet: We've seen what kind of effect this rate environment has had on the balance sheets of large corporations. Even firms with gigantic negative free cash flows like Chesapeake Energy (CHK) don't have any trouble finding reasonable financing. Dell on the other hand spends almost nothing on CAPEX, and can be expected to earn at least $3 billion in annual free cash flow going forward. Moreover, earnings have simply not been in a "free-fall." As I've noted in previous articles, Dell's image as a failing PC company is totally misguided. Dell's EPS did in fact drop for the first time in several years in 2012, down from $2.12 to about $1.70. But with the largest acquisitions just taking place recently and the PC business slowing down even faster than anticipated, the performance really wasn't that bad. The higher margin businesses grew modestly in 2012, with servers and networking leading the way in Q3 at 11% sequential growth. Earnings appear to be bottoming, with the mid-range estimate (one that I believe will come in too low) calling for $1.67 in the current year's (fiscal 2014) earnings.
Dell continues to be misunderstood in the public eye, which is probably driving the motivation to go private. Silver Lake and TPG seem motivated to take advantage of ultra-low rates, potentially the lowest rates we'll see for decades, in order to buy a company for less than 6 times EBITDA, and only about 7 times future annual FCF, and major banks are starved for big deals.
UPDATE: The latest headline from The Wall Street Journal is that Dell is now talking about a deal between $13 and $14, making the risk-reward profile of getting long the shares pretty unattractive.