Dell (DELL) shareholders would do better to hold on to their stakes than to offer them up to the privatization scheme presented to them last week. That's what a Barron's article suggests in this week's copy of the magazine. It is also what I suggested on the message board at the Wall Street Greek blog minutes after the deal was announced, but before questions were publicly raised about the plan. It's my view that the company will create value over the next year or two, and that the question is only for whom will that value be created, shareholders or private holders. I think it should be the shareholders, who have borne the costs of the company's struggles up until now, and also those who just became holders after recognizing a value opportunity, who should profit in a turnaround.
The intended private investors might argue that public market stresses and investor impatience make the plan more difficult or even impossible to accomplish as the company stands today. Some might say the best cost capital for such an effort is found through debt and private investment funds, and that the plan is simply the best option for DELL. Private equity impetus might be exactly what Dell needs to revive its look and feel, and get back in the game, but why can't the company reinvent itself?
I think the truth is that a special opportunity exists in DELL, and that the smart money involved here is seeking greater participation in that opportunity. It's all perfectly legal, and an opportunity exists today for new groups of investors to make offers that would cut into the planned profits of the initial proposal, but still likely grow significant wealth. Also, shareholders may vote against the plan, and leading outside holder, Southeastern Asset Management, said Friday that it would do exactly that. There may be a price point adequate for DELL shareholders to cash out and save time, but it would seem the first price offered might not be it. Interested parties will certainly note where the stock traded before whispers were heard about the plan, and warn that DELL could rediscover lows if the deal falls through. However, truth be told, the word is out now that smart money sees value in Dell, and that information is worth a few dollars too.
When this story initially caught the winds of Wall Street whispers, it was seen as an out-option for shareholders in a company that perhaps had seen its day. That is also the way the story was told by the quick-triggered popular press and by tech-bloggers on the day it was publicly announced by Dell. However, shareholders should understand that nobody makes a bad deal intentionally. The simple fact that Michael Dell, Silver Partners and Microsoft (MSFT) see value should trigger interest in shareholders to at least take a closer look and to possibly hold on to their stakes. Also, Wall Street financiers participating in this deal, including BofA Merrill Lynch (BAC), Barclays (BCS), Credit Suisse (CS) and RBC Capital Markets (RY), don't generally lend money where there's not a high likelihood of payback. I say that whatever can be done with new debt might also be accomplished with the great store of cash (on net) held in Dell coffers these days (about $5 billion according to Barron's - cash and equivalents are $13.8 billion before looking at current liabilities). And the fact that insiders are interested in participating in and directing the plan makes it all the more questionable for shareholders.
DELL shares have lagged the market (both S&P 500 and the NASDAQ) over the last five years, and done especially poorly over the last year. The reason for it is generally understood to be due to the evolution of technology. The company could not produce a competitive tablet without a competitive Microsoft operating system (its Android operated "Streak" product was hardly noticed early in the season of the iPad), and so Dell watched market share bleed out of its PC business to Apple and its iPad tablet segment, and to every other tablet maker. However, today Dell is offering both new tablets and innovative new convertible tablet/laptops, which should garner new market share of their own in my view. If the company were to make better gear that also looked the part, I believe it could find its way through tough times into consumer's welcoming arms. I see no reason why Dell and Microsoft can't make that happen, given their respective resources. With time, the field is leveling against Apple's "App" domination, and Apple (AAPL) is slowing in its own innovation.
There will always be a place for the PC, especially in the secure workplace. The addition of laptops and tablets has only broadened computing, as has mobile. For as long as Dell competes, it brings a brand many consumers trust to new computing devices. Sure there are skeptics and plenty critical bloggers bashing Dell, but I see a value opportunity and a brand worth valuing more highly. Even though it's behind in the tablet game, I believe Dell is already innovative enough to regain lost ground in hardware. The company has spent some money acquiring software and service businesses, and sees those as additive to growth. I think there's plenty of opportunity for the Dell brand internationally as well.
Oftentimes when public companies are taken private, either by private equity firms or corporate insiders (in this case both), it's because there's value to be unleashed that is not captured by a beaten down stock price on its recent performance. "Smart money" has been so named for a reason. Michael Dell likes his company's shares, and stands to make money and retain control of the company he founded if the deal is consummated. I would bet the deal was not his idea and that Wall Street had to include him and let him retain (or rather grow) his stake in order to win the deal. But I have another idea.
Dell should buy back its shares if it believes in the company's outlook, and in so doing, do right by its shareholders. Where it can't innovate fast enough, it should acquire with its cash store and extend its brand across computing. This company is not being rescued from the dead out of the depths of near bankruptcy. It's a company that slipped, but can now pick up the pieces and create value for shareholders. If I were retained as a consultant for Dell, that's what I would focus on. I would compete with Apple on price and make effort to provide value without giving up performance or look.
Because I believe this is possible, I don't expect the $13.65 being offered to shareholders will be adequate to gain those shares. That is just 8.2 times the analysts' consensus expectation for EPS of $1.66 for fiscal year 2014 (January). The Barron's article reports that "most leveraged buyouts are done for double the Dell transaction valuation." So what we have here is a mismatch: a company that is appealing enough for insiders and smart money to take interest in, but that is valued at a level more appropriate for a failing business. In the efficient market, this high profile company is not likely to be had at such a level. Given the shares trade at a premium to the current offer, it's clear the market agrees. So I suggest shareholders stay long and new money take note of the opportunity.