Silver Lake's $13.65/share offer for Dell (DELL) may be at risk given recent trends in the PC space along with news of Blackstone (BX) losing interest in pursuing a transaction. This actually presents an interesting opportunity to enact a bearish position on DELL given the risk/reward in light of rapidly deteriorating PC sales, DELL's current share price and embedded bid valuation, Silver Lake's proposed buyout price, unlikely emergence of any competing bids, and a number of sour/dissenting shareholders that could end up with egg on their face should the transaction not close.
Last week, IDC issued a report stating that global PC sales declined by 14% in Q1 2013 compared to Q1 2012. This was worse than expected and came as a surprise particularly given expectations that Windows 8, despite a tablet-centric OS, would be able to spark some interest in traditional PCs. IDC noted that Windows 8 actually exacerbated the industry slowdown due to a confusing array of feature differences between tablet mode and traditional PC use. I've stated that Microsoft (MSFT) is an attractive short, particularly given its poor leadership and high dependency on PC sales.
Following the IDC data, Blackstone announced that it would withdraw from the bidding process for DELL. One concern Silver Lake and founder Michael Dell could have is that Blackstone's analysis revealed something they initially missed. In addition, the pace of the PC declines in Q1 could be a surprise to Silver Lake which could prompt it to reconsider its buyout. Lastly, a top tier firm like Blackstone stepping away will likely reduce the interest other firms have in generating a competing offer.
At $13.30 or so, DELL offers just 2.6% upside if the Silver Lake deal is approved by shareholders. In light of recent news regarding PC sales I think there's an increasing likelihood that Silver Lake reconsiders its buyout. What also helps any potential DELL bear is the fact that a good portion of its shareholders including Southeastern Asset Management, Yacktman, Pzena, and Carl Icahn have been very vocal in opposing this deal. I think they could also sway other value oriented shareholders of DELL such as Dodge & Cox, Harris Associates, and Templeton Global to also oppose the deal. The prospect of delaying a vote or increased dissension favors any bearish speculators because it allows time for further news flow in subsequent quarters that could paint an even more troublesome picture for PC sales and increase the likelihood for Silver Lake withdrawing its bid.
To be clear, Silver Lake is a tech-savvy buyout fund. Technology is its specialty but recent history (Second Curve Capital/financial stocks; JC Flowers / MF Global) demonstrates that sector specialization is not always material in preventing losses. Silver Lake would also be on the hook for a $750MM break up fee. However, these agreements are subject to material adverse change (MAC) clauses which could greatly reduce the penalty for Silver Lake to walk away. With operating income projections declining from $5.6B to $3.0B in the course of a year, there could be legal language within the agreement that triggers some escape hatch for Silver Lake.
In fact, Silver Lake and recent MSFT investor ValueAct, jointly walked away from acquiring Acxiom (ACXM) in 2007. An interesting parallel to the DELL deal was that ACXM had a contingent of opposing shareholders when the deal was announced in May 2007 citing the offer as inadequate. When Silver Lake and ValueAct withdrew their bid in October 2007, ACXM shares fell by 20%.
I think a case could be made that DELL could drop by a similar amount which is what makes a short at this level, with limited downside and what I think is an increasing probability of the deal falling apart, attractive. HPQ is DELL's closest comp and trades at 3.7x LTM EBITDA. The Silver Lake bid has inflated DELL's valuation by a full turn, to 4.7x LTM EBITDA. Removing the Silver Lake bid would value DELL at roughly $10.50 if using HPQ's EV/EBITDA comp. DELL's stock price action suggests that the deal will close but with a fiscal Q2 close targeted for the buyout, bad industry news, and shareholders wanting a higher bid, the risk/reward to a bearish speculation on DELL seems attractive.