Leveraged buyout offers for Dell (DELL) were expected since August as the company found it difficult to fight its challengers like International Business Machines (IBM), Hewlett-Packard (HPQ), and Microsoft (MSFT) in business products and services. Unfortunately, the current price of Dell shares has effectively priced in the takeover deal. This is not an attractive play at this time.
Dell Buyout Prospects
Michael Dell, Dell's CEO and founder, along with Silver Lake, has offered a deal totaling around $24 billion after considering leveraged recapitalization. Shares of the company closed around $14 on March 7, 2013 in New York, a price higher than the existing takeover offer of approximately $14 per share. The shares have gained 40 percent this year as compared to a gain of around 8 percent for the Standard & Poor's 500 Index.
Dell's deal was aggressively opposed by minority shareholders like Southeastern Asset Management, T. Rowe Price Group and Richard Pzena, founder of Pzena Investment Management (PZN). According to Southeastern, the current takeover price is lower than Dell's current worth, as it has assessed Dell's worth $24 a share in a recent regulatory filing. Southeastern, which holds around 8 percent stake in the company, also solicited names and addresses of shareholders, who hold shares through different compensation and share-ownership plans, to discuss the deal with them. Weekly update on changes in this information has also been sought. Southeastern made this filing in the U.S. Securities and Exchange commission on behalf of Longleaf Partners Fund along with the objections against the said deal. Southeastern's O. Mason Hawkins and Staley Cates pointed out, "The board of directors characterizes the proposed transaction as a transfer of the risk of the business to the buyout group. We believe it is more appropriately characterized as a transfer of the opportunity of the business to the buyout group." They also wondered how Dell changed its stance on repatriating cash for buyout which it holds overseas. Dell previously refused to do so quoting deduction of taxes as the reason. It is also to be noted that Southeastern would have to pay an extra $7 per share to gain the voting rights, as per their shareholding in the company, which would cost them around $16 a share. It is because they bought options on 25 million shares. Southeastern cannot vote on another almost 17 million shares held on behalf of clients. Excluding these shares and options, Southeastern would only have a voting right on 6 percent of Dell's stock.
Carl Icahn, who also gathered a stake in Dell, requires the company to pay a special $9 per share dividend if this takeover fails. If Icahn's offer is not accepted, he plans to start a proxy fight. Some shareholders are definitely not happy with the buyout as an analyst at Standard & Poor Angelo Zino said, "There are some disgruntled shareholders and they think Michael Dell is kind of bullying them around." In addition to shareholders, Blackstone Group (BX) along with competitors Hewlett-Packard and Lenovo Group also showed interest. Although these competitors are unlikely to bid, they are reviewing and considering information which is only made available to the potential buyers in the go-shop period.
According to Oscar Gruss & Son's Louis Meyer and other analysts, the offer could be revised to around $15 per share. Meyer expects that the corresponding increase in debt should also be manageable. GFI's Alfredo Scialabba also said that the consortium would easily pay if the increase in bid to $15 per share occurred. Sterne Agee & Leach's Wu said that this expected increase in bid will require Microsoft, another loan provider for the buyout, to pay more than the initial $2 billion. However, it is still undecided whether Microsoft will be willing to do so. Even if the offer price is to be increased to $15 a share, this would be the cheapest buyout for a technology company worth more than a billion dollars. At $15 a share, Dell would have a diluted enterprise value of about $23 billion, inclusive of around $4 billion cash, which is 5.4 times of earnings before interest, taxes, depreciation and amortization. Jefferies' Peter Misek wrote, "Enough minority shareholders likely would approve a bid of $15 a share, and it would still yield a 19 percent to 21 percent internal rate of return for the buyers. The activist investor likely would be appeased by an increase to $15 a share, a higher price than would be generated in a leveraged recapitalization."
According to Jim Chanos of Kynikos Associates, the share price of Dell could fall below $10 if the deal is not through.
Reconciling Market and Deal Prices
Let's consult the market for outcomes. In general, the odds of a cash-for-stock takeover going through tend to be high, over 80%. Let's use that as an estimate. If we use Mr. Chanos's $10 as a conservative measure of a share price drop, we can back out the implied value of a deal that the market is pricing into Dell shares, which are currently trading at $14.25.
Current Share Price = P(Buyout) x Buyout Price + P(No Buyout) x Price with No Buyout
Using a little algebra:
Buyout Price = [Current Share Price - P(No Buyout) x Price with No Buyout] / P(Buyout)
Buyout Price = [$14.25 - 20% x $10] / 80%
Buyout Price = $15.31
This is higher than the current offer, and could conceivably be achieved by a third party entering a bidding war or through renegotiation on behalf of shareholders.
As an investor, I am not really interested in market prices that have higher bids priced in. I think the opportunity to catch Dell shares at a bargain price has passed.
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