The secular decline of the PC market should make any investor question why Dell (NASDAQ:DELL) should obtain a premium valuation to the LBO offer of $13.65. The company has limited traction in the mobile sectors of smartphones and tablets, suggesting the business is only getting worse, not better.
The stock should've been hammered Friday on the report by David Faber on CNBC suggesting the operating income forecasts used to value the LBO will be cut. The stock though actually rose for the day to close at $14.31 and above the offer.
The company agreed back on February 5th to be acquired by CEO Michael Dell and Silver Lake. Under the terms of the agreement, Dell shareholders will receive $13.65 in cash for each share of Dell common stock they hold, in a transaction valued at approximately $24.4B.
The deal provided a premium of at least 25% over the prices prior to the rumors of a possible going-private transaction on January 11th.
The stock now trades at a price above the cash offer as numerous shareholders view the valuation as unfriendly to outsiders. Using normal valuation metrics one might assume a higher valuation for the company though concerns exist regarding the secular decline of the PC business.
As mentioned above, Faber brought up the possibility that the operating income of Dell has plunged considerably below the estimates used to value the deal. In that scenario, the deal could even fall apart versus the higher offer expected by the market.
The updated details to be presented in the merger proxy in the last week of March as provided by Faber:
- July plan had FY14 operating income at $5.6B.
- Recent management update had FY14 operating income at $3.7B.
- News suggests the number might be significantly below the most recent estimates.
- BCG advised that Dell would be unlikely to reach an operating income of above $4B for years.
Faber presented a scenario where increasing the offer would be highly unlikely. A consortium of lenders would be very unlikely to step in front of a sliding business such as that one.
A lot of investors are using the recent ramp in Hewlett-Packard (NYSE:HPQ) stock as an indication that Dell deserves a higher price. Investors though need to be cautioned that using a limited time frame can skew that perception. When looking over a 5-year period, Dell has significantly outperformed Hewlett, suggesting that if anything it is now playing catch up.
At this point, most investors should consider themselves lucky to be able to obtain a premium to the merger price. The evidence suggests Dell's business is only getting worse after the 8% revenue decline last year.
Investors need to be careful making snap judgments regarding the recent price action in Hewlett-Packard. Most valuation methods and long-term trends suggest Dell is already overvalued compared to Hewlett-Packard.
Investors should sell the stock as quickly as possible. The likely scenario is a maximum of $15 on the upside and possibly plunging back to $9 on the downside. The risks appear to greatly outweigh the rewards.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in DELL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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