Conclusion first: I believe that Dell's (DELL) proposed go-private offer of $13.65 per share grossly undervalues the company and view this attempt to short-change public shareholders as an epic failure of fiduciary duties. In this article, I lay out in simple and clear terms why I hold this view and urge shareholders to vote against the deal.
All casual financial observers should by now be aware of Dell's proposed go-private deal of $13.65 per share led by Michael Dell, the company's founder and CEO, and Silver Lake, a well-regarded private equity firm. The price of $13.65 per share represents a ~25% premium over the stock's close prior to the proposal. To uninterested observers or unsophisticated shareholders, this may appear as a windfall, a coup de grace to public shareholders after more than a decade of declining stock value.
According to a recent Wall Street Journal article, "Interviews with current and former Dell executives, plus other people who know the CEO, paint a picture of a man who appeared increasingly worried about his legacy." If the proposed deal goes through, Michael Dell's legacy is clear enough in my mind - suffice to say an appropriate title for his biography would be "The Art of the Steal."
To shareholders who view their stock holdings as an economic interest in businesses and who have placed their faith in management and the Board to protect their interests, the proposed and accepted $13.65 per share deal is looked upon as an attempted robbery and an epic failure of fiduciary duties. Why? For two reasons:
- There is absolutely no need for Dell to go private other than the motivation of Michael Dell's greed, and
- $13.65 per share undervalues the company by at least 42% (i.e. conservative estimation of per share value is 74% higher than the proposed deal).
No need to go private
Going private via a leveraged buyout creates economic value under certain circumstances for certain companies. When the conditions are met, public and private equity investors share the economic value by striking a deal at a price somewhere between current market valuation and the present value of the expected exist value to the private equity investor. Unfortunately, the primary advantages of going private do not apply to Dell. Advantages include:
- Better align management interest with shareholder interest. Since CEO Michael Dell is by far the largest shareholder, this does not apply to Dell.
- To escape the market's focus on short-term results to focus on more profitable, long-term strategies. For the same reason as (1), and since most shares are held by institutions, including many value-oriented, long-term asset managers, this also does not apply to Dell.
- Changing strategic directions. This advantage is similar to (2), and for the same reasons as above, this also does not apply to Dell. In addition, the company is currently executing a strategy that management and investors are very much in favor of (i.e. transforming itself from a manufacturer of commodity products to a technology services company like IBM).
- Optimizing capital structure and tax efficiency through leverage. Given the low interest rate environment, there is no reason why this cannot be done as a public company. Southeastern Asset Management estimates that Dell will be able to undertake new borrowings of $9.0 billion at 7% in a 2/9/2013 letter to the Board of Directors (more information and link below).
According to a 2/6 Financial Times article, "no member of Mr. Dell's consortium offered details of the strategy, or specifics on how being private would benefit the company." In my opinion, the only reason why Michael Dell wants to take Dell private is because he sees an opportunity to make a tremendous profit at the expense of shareholders.
Dell's shares conservatively valued at $23.72 per share, or 74% higher than current proposal
I have independently valued Dell's shares at a minimum of $20 per share and many investors and analysts have independently valued Dell's shares at some price much higher than $13.65 (these opinions can be found on Seeking Alpha, sell-side research, and elsewhere). Instead of going over my valuation, I will instead direct the readers' attention the very strong case laid out by Southeastern Asset Management arguing that Dell shares are conservatively valued at $23.72 per share.
Last Friday (2/8), Southeastern Asset Management, led by the famed value investor O. Mason Hawkins, has publicly, thoroughly, and vehemently expressed their displeasure at the $13.65 proposal, and explained why they believe each share is worth at least $23.72 in their letter to the Board of Directors (see SEC filing here). The key points are as followings:
- Net cash per share after deducting structured debt within Dell Financial Services (DFS) is $3.64.
- Dell Financial Services has a book value of $1.72 per share.
- Since Michael Dell resumed his role as CEO in 2007, the Company has spent $13.7 billion or $7.58 per share on acquisitions. During Dell's June 2012 analyst day, Dell's Chief Financial Officer Brian Gladden said that in aggregate the acquisitions to that point had delivered a 15% internal rate of return. The Company has neither taken nor discussed the need to take any write-downs of these acquisitions. Therefore, the acquisitions are worth a minimum of their cost.
- Taken together, these items total $12.94 per share before we even look at the other businesses.
- The value of other businesses net of unallocated expenses is at least $10.78 per share, and does not even consider Dell's strong product distribution capability.
Other Implications of Southeastern Asset Management's Letter to the Board of Directors
In addition to placing a floor value on Dell shares, Southeastern also condemned the Board by more or less saying "you could have done X, Y, and Z to maximize shareholder value, but you did not, so thus failed to perform your fiduciary duties as required by law." Specifically, Southeastern noted that Dell could have paid shareholders a special dividend close to $12.00 per share, while still retaining the ability to generate anywhere from $1.14 to $1.34 per share of free cash flow per year, or allowing public participation in the private equity deal (i.e. allowing for a public stub) instead of forcing shareholders to cash out.
Given that Southeastern is the second largest shareholder after Michael Dell, and given the strongly worded letter and the between-the-line messages therein, I believe there is a strong chance that the current offer of $13.65 will either be substantially raised or rejected.
As I was writing this article on Friday (2/8), Dell shares went above the offer price near the market close and closed just slightly below at $13.63, signifying a general belief that the offer price will be raised. In addition, articles documenting the rising shareholder revolt are popping up. For example, according to a 2/9 Reuters article, "Harris Associates LP, Yacktman Asset Management and Pzena Investment Management LLC - which together hold 3.3 percent of Dell's outstanding stock… now plan to vote against a buyout that would end Dell's turbulent 24-year ride on public markets." Note that this is in addition to Southeastern's 8.5% position.
If the buy-out deal is rejected, shares will likely drop by a significant amount in the short term. However, given recent developments, it is unlikely shareholders will simply sit back and wait for Dell's turnaround and transformation as they have before, not after management and the Board tried to steal the company. If the deal is rejected, management will be forced (likely under the duress of lawsuits) to do something to realize shareholder value. Options include paying out the special dividend as suggested by Southeastern, aggressively buying back shares, selling off pieces of the company, or employing other vehicles to return capital to shareholders.
In my opinion, current shareholders should brave any potential, short-term market fluctuation, and vote against the deal as it is structured now. Furthermore, shareholders should let their voices be heard through any one or a combination of the following channels: 1) social media and traditional media, 2) writing to Dell's management and Board, or 3) if you hold shares of Dell through a fund, writing to your portfolio manager. For shareholders with substantial resources, lawsuits would be another option.
In the spirit of full disclosure, my cost basis for Dell shares averages to ~$15 per share, and I will not consider anything under $18 per share from the buy-out consortium.
Disclosure: I am long DELL.