Dell's move to go private has become very complicated as investor Carl Icahn has acquired a hefty stake in the company so he can push for a special dividend to shareholders of nine dollars a share and more leverage.
Icahn's proposal, which revolves around roughly a six percent stake in Dell according to CNBC, could be good for Dell shareholders.
Unfortunately, Icahn's proposal might severely damage Dell as a serious enterprise technology player when the fear uncertainty and doubt parade starts rolling.
According to Icahn's letter to Dell the investor's master plan goes like this (emphasis mine):
Rather than engage in the Going Private Transaction, we propose that Dell announce that in the event that the Going Private Transaction is voted down by shareholders, Dell will immediately declare and pay a special dividend of $9 per share comprised of proceeds from the following sources: (1) $4.26 per share, or $7.4 Billion, from available cash as proposed in the Going Private Transaction, (2) $1.73 per share, or $3 Billion, from factoring existing commercial and consumer receivables as proposed in the Going Private Transaction, and (3) $4.26, or $5.25 Billion in new debt.
We believe that such a transaction is superior to the Going Private Transaction because we value the pro forma "stub" at $13.81 per share using a discounted cash flow valuation methodology based on a consensus of analyst forecasts. The "stub" value of $13.81 combined with our proposed $9.00 special dividend gives Dell shareholders a total value of $22.81 per share, representing a 67% premium to the $13.65 per share price proposed in the Going Private Transaction. We have spent a great deal of time and effort in determining the $22.81 per share value and would be pleased to meet with you to share our analysis and to understand why you disagree, if you do.
Here's a simplification of Icahn's proposal:
- Dell would take on more debt to pay a dividend to shareholders.
- Dell would leverage its receivables to pay out some of that dividend.
- Dell's cash position would be eroded.
Given those three moving parts, it's no surprise that Jefferies analyst Peter Misek noted that Icahn's leveraged scenario is a worst-case scenario. Misek noted that net leverage would still be manageable in each scenario, but Dell would face more interest rate expenses each year. Historically, companies leverage and recapitalize and lose flexibility.
We have updated our leveraged recap model post-earnings. We think that Icahn would likely be satisfied with a raised bid to $15, which we think would be higher than the potential stock price realized from a leveraged recap. Even if the deal does not get shareholder approval, we view the leveraged recap as the worst-case scenario.
Rest assured, Icahn won't give a hoot about Dell once the dividend is paid out in his scenario. As a result, Dell could have a lot less flexibility — due to debt — to refashion itself as a mini IBM. Dell will also have less cash to compete with Lenovo and HP. It's worth mentioning that both Lenovo and HP are looking at Dell as a potential acquisition (wink wink). Simply put, HP and Lenovo are saying they might be interested in Dell so they can get all the data possible on a rival.
Should Icahn get his way, rivals will have a field day with Dell. HP wasted no time mocking Dell's plan to go private and noted the company would have too much debt. If Dell takes on more debt, every competitor will note that the company will be saddled whether it's reality or not.
All Dell competitors have to do is cast some doubt on the company and they can win deals. In other words, FUD works. HP knows this lesson well. Oracle launched a war on Intel's Itanium chip, which powers HP's high-end systems, and HP's sales in that department never recovered (to date).
Maybe if Dell were debt free, leveraging the model for a payout wouldn't be so bad. The reality is that Dell has a decent bit of debt now. As of Feb. 1, Dell had $12.57 billion in cash and equivalents as well as $3.84 billion in short term debt and another $5.24 billion in long term debt.
It's worth noting that the debt current (total debt divided by total assets) ratio for Dell, IBM and HP are all in the same range. HP's debt quick ratio is 1.12 and IBM's is 1.13 and Dell checks in at 1.19. If Icahn's deal changes those ratios, rest assured Dell will make for an easy target.