In the past week Michael Dell's attempted LBO of Dell Inc. (DELL) has gotten exponentially more complicated. The financial press, in typical form, has responded with a flurry of opinions with wide varieties of perspective and rationale. Unfortunately, it is my opinion that the majority of pieces available spent far more time being edited than researched, resulting in many high profile pieces that utilize flawed or self-contradictory logic. Others simply fail to factor in a large portion of the available public information relating to the deal.
Note: This article is a follow-up and continuation of my previous article evaluating DELL's controversial buyout. Based on a breakdown of ownership, I argued that Michael Dell's initial bid of $13.65 was never intended to go through, and that he had intended to raise his bid to $17-18 from the beginning.
Similar to my first article, I will provide background information with relevant data and minor commentary, and then follow with analysis. Due to the short time interval of the topics covered I will organize by topic rather than date as I had done previously. The opinions expressed below are my own hypotheses based on personal research, and I would enjoy hearing other well-supported views. I've included citations so that you can verify and evaluate for yourself. I will use Dell Inc.'s ticker, DELL, in all caps to refer to the company in order to avoid confusion.
The street was very confident in the strength of buyout until my first article was published. Every news source and analyst was chirping that the deal opposition only had 14% or less to vote against the deal. That was, and is, completely false. My previous article details why the deal was not only weak, but doomed from the start at $13.65.
Enter Sandman: Unfortunately for anyone supporting a deal at $13.65, a massive wrench got thrown into things about 3 hours after my article was published. Carl Icahn, a corporate raider ranked as the 3rd most feared financier of all time, announced holding over 6% of DELL shares, with intent to keep buying. Icahn, apparently not satisfied with the drama from Herbalife (HLF), is now the primary threat to Michael Dell's plan to take DELL private.
What's particularly threatening about Icahn in this instance is that it's barely been a year since he and Southeastern took over Chesapeake Energy (CHK) and ousted its face man, CEO Aubrey McClendon. Icahn also has a track record that demonstrates investors' ability to ride his coat tails and produce a strong return, an element that may draw some less sophisticated investors to his side.
Icahn's Strategy: Some speculation has been made as to what Carl Icahn's exact motives are in taking a stance here. Opinions have been published claiming his position benefits shareholders, and others claim it detriments them. Many of these opinions largely depend on some bizarre claims toward Icahn's principles regarding shareholder rights. Other pundits have asserted that Icahn was recruited as a pseudo gun-for-hire by Southeastern Asset Management and other vocal opposing shareholders such as T. Rowe Price and Pzena Invesment Management (PZN). The logic behind this theory is that Icahn, unburdened by the rules governing asset managers, can provide the unbridled firepower and vocal opposition necessary to force a higher deal price. Some even hypothesize that Icahn merely does this sort of thing for fun, and honestly I think this may very much be the case, though it's not his motive.
All of the opinions above completely miss the point in their attempts to find patterns where patterns do not exist. Carl Icahn's motives are not complicated. He is not battling for or against the principles of equity share ownership. He is not doing his buddies at Southeastern a solid. He is certainly not acting on a whim for fun. Carl Icahn is trying to make money, plain and simple. He saw a weak deal and attacked it. Yes, he is able to leverage shareholder rights as a moral issue and yes, he does have a longstanding relationship with Southeastern, but neither is his motivation. As I highlighted in the my article, Michael Dell had no shot of taking DELL private at $13.65, and I think he planned to up his bid a few dollars and take it private without any issue. Even if that was not the case, both DELL management and the street at large considered the deal to be rock solid, and that is exactly why it was so exposed to a player like Icahn.
Icahn Non-Public: Prior to going public, Icahn initially pondered making a $15 tender offer for the company, but chose not to. The argument has been made that this consideration shows Icahn to be a danger to shareholders, however, that is simply not the point. Viewing information that way is an attempt to conform incoming data to a personal view of how things work, not an attempt to conform personal views to incoming data. Recognizing the difference is absolutely paramount to being a great investor. That Icahn considered a $15 tender offer and chose not to make it tells us the following: Icahn thought $15 was too expensive for the company or he thought he could make more money by pursuing a different course of action. If Icahn thought $15 was too much for the company he would rationally have to assume the same would be thought by others, and thus he would have backed away from DELL rather than continue to build a stake in the company. The size of Icahn's equity stake shows that he does believe in the value of the firm, because he would have massive downside exposure otherwise if he was merely trying to play politics around the deal. Thus we are left with Icahn believing he can make more money by taking a different course of action, as he did.
Icahn in the Spotlight: Icahn burst onto financial headlines (again) with a public letter sent to DELL management. The letter is a tour de force that denounces Michael Dell's buyout, calls for a leveraged recap to fund a $9 special dividend, promises to vote down Michael Dell's $13.65 LBO, and vows a lengthy legal brawl otherwise. Icahn also demands the opportunity to vote in different directors to the Board if the Board will not act on Icahn's leveraged recap plan after the LBO is voted down by shareholders. Icahn even goes so far as to personally offer financing for the leveraged recap. One of the key paragraphs follows:
"However, if this Board will not promise to implement our proposal in the event that the Dell shareholders vote down the Going Private Transaction, then we request that the Board announce that it will combine the vote on the Going Private Transaction with an annual meeting to elect a new board of directors. We then intend to run a slate of directors that, if elected, will implement our proposal for a leveraged recapitalization and $9 per share dividend at Dell, as set forth above. In that way shareholders will have a real choice between the Going Private Transaction and our proposal. To assure shareholders of the availability of sufficient funds for the prompt payment of the dividend, if our slate of directors is elected, Icahn Enterprises would provide a $2 billion bridge loan and I would personally provide a $3.25 billion bridge loan to Dell, each on commercially reasonable terms, if that bridge financing is necessary."
Calling to mind Icahn's 6+% (and likely growing) stake in DELL, this letter is a much bigger threat to Michael Dell than people seem to realize. By putting into place an ultimatum that is only triggered after Michael Dell's buyout fails, Icahn has effectively eliminated the frequently tossed around risk of DELL falling out of the sky and becoming "an $8 stock", as Silver Lake argued. Thus, there is effectively a floor in the stock. If the deal does not go through, or if Michael Dell walks away, Icahn can certainly muscle his proposal through, assuming he retains the backing of Southeastern and other holders. Icahn argues the recap would unlock $22.81 of value per share, and it would be very difficult to argue that there would be significant opposition to that.
Icahn's Poker Face: If you look at Carl Icahn's record, there is no way he is anything close to the emotionally volatile, potentially psychopathic buffoon the media often paints him to be. According to a Bloomberg report of Icahn's marketing materials, he was able to generate a 53% annual return from January 1996 to May 2004. In 2008 he dropped 36%, versus the average hedge fund loss of 20%. Even so, he returned 35% in 2011 and 28% in 2012. Personally, I think Icahn actively plays into the popular perception, but if that is how an idiot performs, I want to be an idiot.
During his "Hedge Fund Superdome" verbal brawl with Bill Ackman live on CNBC he often sounded confused, misquoted numbers, and generally played the role of an angry, senile old man flawlessly. But nothing Icahn does off the call is confused, numerically inaccurate, or emotionally biased. He's taken measured, deliberate positions in Herbalife and moved strategically to capitalize on his position. The man we heard on the phone would have no such tact.
Even in his letter to DELL, he makes some interesting miscalculations in his leveraged recap calculations, errors that led Dan Primack, a writer for Fortune, to publish a piece entitled "Icahn's Dell math gets an F." Again, what is interesting is that the reality behind Icahn's supposed stupidity is distinctly more positive for Icahn than his façade. Primack argues that under Icahn's own assumptions there should be an extra $1.25 per share. This could easily be attributed to various fees and taxes, but it serves regardless as an excellent example of what I believe is an act. Whatever you think about Carl Icahn and his position in DELL, he is arguably the single largest player involved, and he has fundamentally changed the landscape of the deal.
Icahn Confidential: The most recent, and possibly shocking, update to this drama came on March 11, when Icahn formally entered into the go-shop arena by signing a confidentiality agreement and gaining access to DELL's books. Where Icahn does specifically from here is unclear, but there is one sure thing: he will do what makes him the most money. His silence is only temporary, so he remains perfectly able to execute the threats laced throughout his letter. Additionally, he will have a much stronger position from with to debate and potentially litigate having seen the books. Icahn knows that a miniscule raise in the bid price will draw the same ire as Michael Dell's, so he likely will not make a bid unless he is going to increase it materially. I think a reasonable minimum for such a raise is $16, since $15 is not a material increase from the current share price.
Icahn has until the end of the go-shop period to make a tender offer, which could come in the form of an attempt to form Michael Dell higher or a legitimate attempt to take the company private. As displayed in Icahn's dissection of TWA, he would have no reservations in cutting DELL up into pieces and auctioning them to the highest bidder, and he's actually quite good at it. This being the case, the go-shop period is the paramount issue to watch in the future of DELL.
Go-Shop Threat Upgrade: Almost immediately following Icahn's letter, Blackstone (BX) was revealed as having signed an NDA with DELL so that they could shop the deal. With BX on-board as a potentially vetting source for the deal, DELL officially had Goldman Sachs (GS), Evercore Partners (EVR), and Blackstone servicing the deal to potential acquirers. Bank of America Corp. (BAC), Barclays PLC, Credit Suisse AG, and Royal Bank of Canada are arranging financing according to the WSJ.
More recently, Michael Dell's group hired Citigroup (C) for M&A advisory services, while J.P. Morgan Chase & Co. (JPM) advise DELL's special Board committee. Long story short, all of Wall Street (aside from Morgan Stanley (MS)) has some interest in vetting this deal.
Competing Acquirers Emerge: Hewlett Packard (HPQ) and Lenovo were the initial leading ideas as acquirers, with Cisco Systems, Inc. (CSCO), IBM (IBM), 3M (MMM), Intel Corp. (INTC) lingering as speculator contenders. Ignoring speculative choices, HPQ and Lenovo are unlikely to bid because they both would only be capable of, or interested in, purchasing specific business units/assets, not the company in its entirety. HPQ is also weary of acquisitions currently, and buying anything would be a complete 180 degree turn in their strategy as a company.
Selling parts of DELL may be an intelligent decision at some point in the future, but in DELL's tumultuous current state it would be risky at best, and a sale would likely damage the total value of the firm. Thus DELL as a public company or as a private one under Michael Dell would absolutely not be interested in any proposition HPQ or Lenovo could make. But the same cannot be said for Carl Icahn. If Icahn decides to go old-school "chop shop" on DELL, HPQ, Lenovo, and many others become viable buyers. With today's rate environment providing easy leveraging options and DELL trading near all-time lows, it is a beautiful candidate to be sliced up and sold.
Wall Street Apathy: The information I've discussed in this article, as well as my last, is all easily accessible via public resources. I am not particularly sneaky in how I do my research, I'm just thorough. A few hours surfing the web can produce the majority of what I've said here. But it's painfully clear that none of the pundits or analysts covering DELL have thoroughly researched this deal (either that, they're incompetent, or they have ulterior motives in their coverage). I'll give them the benefit of the doubt and just give a couple examples.
Brian Marshall, a Senior Managing Director at ISI Group, went on Bloomberg TV to discuss the buyout. He argued that the size of Dell's operations implies that it will take "non-trivial" time to turn the company around and cited Dell's $2bn storage business taking "5 years" to turn around as a basis for the time it will take to turn around Dell's aggregate ~$50bn in annual revenue. Marshall claims that it makes sense to "go private, fix it behind closed doors, and then emerge as a growing entity with smaller revenue base and higher margins down the road." Furthering that, he says that if the turnaround works, the company is worth $25+ per share 3-4 years from now. He closes by stating that he believes Michael Dell's offer is "around fair value" and doesn't see a material increase in bid price. He does think, however, that it is possible for Carl Icahn and others to buy up enough shares to raise the bid.
So, to recap, Brian Marshall essentially states that shareholders are getting hosed, but it doesn't matter. Without backing, he takes the same nonsense position as everyone else in thinking the deal can go through at $13.65. I can only describe his opinion as disturbingly uninformed. Donald Yacktman, President of Yacktman Asset Management Co., which owns over 15mn shares of DELL, went on Bloomberg TV opposite Deirdre Bolton to discuss the buyout and calmly stated that the deal wouldn't go through at $13.65. That Marshall was invited on as an expert and Yacktman only as a panelist reflects badly not only on Bloomberg, but also on the quality of financial media as a whole.
Another Bloomberg article says the following:
Lifting the offer to "$15 would be the maximum bump that the current consortium would be comfortable paying," Alfredo Scialabba, a New York-based special situations analyst at GFI, said in a phone interview.
Again, that Bloomberg would publish such a baseless speculation is absurd. Of course Michael Dell would have to source additional financing to raise the bid. That's the case when you buy a car, there's no reason why it would be any different. At the same time, though, Bloomberg admits that at $15 Dell would be the lowest EBITDA multiple ever paid for the technology company over $1 billion. The strategic framing of the issue paired with incompetent/uninformed opinions is bewildering. But what about sources other than Bloomberg?
Sadly, the Wall Street Journal's coverage is worse. In an article entitled "The Real Dell Issue Is Michael Dell", Holman W. Jenkins, Jr. goes on a preposterous rant based on the idea that opposition to the DELL LBO is purely based off of a "moral" issue. The article may stand as the greatest example of the "straw man" logical fallacy I've ever seen. It should be in textbooks. The disagreement isn't over a moral dilemma; it's over how much something is worth. It's haggling, not philosophy.
Shareholder Breakdown Update: My last article broke down DELL's holders and showed that (conservatively) 42.969% of shares would vote against Michael Dell's $13.65 buyout. 42.04% of shares are needed to approve the deal. With the addition of Carl Icahn's 6%, 48.969% of shares are against Michael Dell's buyout. That means that not only is there no chance for the deal to go through at $13.65, but opposition is reasonably close to having a majority of shares capable of voting Michael Dell out as a director acting contrary to shareholder interests. Voting Michael Dell off would be more difficult than rejecting his buyout, but the percentage of shares against the deal currently is a powerful example of the extent to which shareholders oppose the LBO.
Potential Damage for DELL: Allowing this deal controversy to fester much longer will damage DELL's value to Michael Dell (or anyone else). Clint Boulton, a reporter for the Wall Street Journal, discussed the potential business impacts of a change in quality of DELL products as a result of the buyout. The sad truth is that even believers of DELL's turnaround cannot argue that DELL provides an advantageous, differentiated product. That should be a major cause of concern to DELL's management because Boulton's hypothesized customer evacuation could easily be triggered by uncertainty. No business wants a supplier with a tumultuous and uncertain future, and Michael Dell is starting to push it. If the deal remains undecided long after the go-shop period ends I would not be surprised to see orders dry up rapidly.
Michael Dell's Conundrum: Michael Dell's offer is not going through. Carl Icahn is waiting in the wings to force a bidding war or a leveraged recap that would drown DELL in debt. DELL's shareholders are infuriated and will be unwilling to accept a bid below $16 (if we are being generous). It is a very bad situation for Michael Dell.
He has to up his bid if he wants to take it private. A raise that's too low will not go through, and he risks a bidding war with Icahn. However, if he doesn't act Icahn will either force a leveraged recap on DELL, effectively killing it, or buy it and sell it for parts.
Key Dates, Likely Outcomes, & Decision Tree: Until March 22, bids can be submitted above the current $13.65 offer. I think to have a realistic chance for success a bid is going to have to be above $16, and the lower the bid is the more likely it is to trigger a bidding war. On March 22 the go-shop period ends. A Shareholder vote will be scheduled on the highest standing bid, and the company will proceed from there. A simple decision tree of this process would look like the following:
Summary and Investor Impact: The only realistic possibility I see that could cause DELL shares to drop is extended litigation, however, I don't think any of the relevant parties are interested in litigation outside of use as a threat deterrent. On the upside, there are several potential future outcomes with varied levels of return, all of which encompass my initial expectation of a bid increase to $17-18. However, I think that the cumulative developments in the deal increase the likely ending bid range to $17-20.
Disclosure: I am long DELL.