An exciting takeover game

Some of the most exciting news in the corporate world are when giant publicly listed companies become targets of takeover battles. The largest such takeover battle since 2007 is just unfolding around Dell Inc, a NASDAQ listed company with market capitalization of $24bn. Dell, the maker of personal computers, was founded in a University of Texas dorm room (where else could a technology company be founded but a dorm room or a garage) in 1984 by a 19-year old student named Michael Dell. Its original appeal was simple – sell machines to American companies, using a lean and flexible “build to order” business model and an efficient supply chain. It grew rapidly to become the world’s leading PC-maker. It was listed in 1988.

Michael Dell dropped out of the university but he needn’t worry about it. His business has made him very rich indeed. The now 48-old CEO of the company that still bears his name, is worth $15.3bn as of March 2013 according to Forbes. Then, in early February 2013, the company announced that a consortium led by private equity firm Silver Lake, and Michael Dell, were offering to take the company private. Their proposal valued the company at $24.4 billion, offering $13.65 a share which represents a 37% premium over the average closing price in the 90 days prior. Mr Dell would roll over his stake, worth $3.7 billion at that price, and add another $750m of equity; Silver Lake would pitch in $1.4 billion; Microsoft, of which Dell is an important customer, would contribute $2 billion in debt; banks would lend $14 billion.

It is interesting to see Microsoft in the deal. The $2bn in debt it is offering may come with some strings attached, such as a commitment by Dell to continue running Windows on its future generation PCs and tablets, or just a general bet on the management team as Microsoft seeks to deploy its formidable cash pile. But why does Mr Dell want to buy his company back again?

It seems that Dell’s expertise in direct selling to domestic corporate doesn’t work nearly as well in the current world where retail sales of PCs to consumers in the developing world matter a lot. The company has fallen from first to third place in the global league of PC producers, with sales lagging those of Hewlett-Packard (HP) and China’s Lenovo. The whole PC market, though still big, may be entering long-term decline. Dell has also failed to develop a mobile strategy and appears taken back by the rise of smartphones and tablets (This year the number of smartphones and tablets in use will exceed the number of laptop and desktop PCs for the first time). Mr Dell responded by following IBM’s and HP’s example and started shifting away from low-margin PCs and towards higher-margin systems and services for corporate customers. But it appears to be too little or too late. Its sales for the year ending in January 2014 will slip to $56.5 billion, and Dell’s PC business will shrink by $10 billion over four years, according to projections in a proxy statement filed by the company with the SEC. Operating income will be stagnant at $3 billion, according to the documents.

Dell’s share price peaked at $54 during the dotcom boom in 2000 and fell to less than $10 in 2012. There are some shareholders, obviously including Mr. Dell, who believe that the shares are now undervalued. Besides that, taking the company private would give Michael Dell a freer hand to restructure the company without having to worry about quarterly earnings’ reports. He should be able to make deeper cuts in the company’s PC operations, which still account for about half of its sales. At the same time, he can devote more energy to its higher-margin corporate-computing business. The firm has already spent billions of dollars on targets such as Quest Software and Wyse Technology. Wyse, in particular, gives Dell a bigger foothold in the booming market for cloud computing, which helps firms save money by delivering cheap software and services over the internet. Michael Dell can then refloat the firm at a higher price once he has turned it around. Silver Lake has experience in just this kind of move. Silver Lake is a technology turnaround specialist which has revived a number of tech firms, including Skype, the internet-telephony service. Dell will however need to tread carefully as it will need the cash its PC business makes to help service the large LBO debt.

But now it seems that Michael Dell has a battle on his hands. After Dell’s Board presented the joint Michael Dell / Silver Lake offer, it allowed for 45 days as a “go-shop” period to see, if any other potential bidders could express interest in the company. Two suitors appear to have done just that. One is a group headed by Blackstone, another buy-out private equity firm, in consortium with Francisco Partners and Insight Venture Partners. The other is Carl Icahn, the 77-year old billionaire activist investor. Mr Icahn, who already amassed a $1bn stake in the company, had complained that Mr Dell’s offer is too cheap. Other shareholders agree. The Dell / Silver Lake price represents a mere eight times Dell’s projected earnings of $1.66 / share in 2014, which is very low. It is lower still when Dell’s net cash holdings are taken into account (The company has billions of dollars of cash in its coffers).

The story of this takeover battle is slowly emerging to public light now. The idea about taking the company private was first touted by one of its shareholders, Southeastern Asset Management, in summer 2012. Michael Dell became intrigued. In August, he consulted his board. In September the Board retained lawyers and investment bank JPMorgan to lead negotiations with Silver Lake and another private equity firm, understood to be KKR. In November, after missing on two revenue forecasts, the stock was trading at a three-year low of $8.86. Silver Lake made its first offer in October 2012 at $11.22-$12.16. It has been forced to increase it 3 times since then. Microsoft was brought to the picture in January 2013. At the same time, another private equity firm, TPG, confidentially inspected the company books, as did General Electric, which was interested in buying Dell’s financing division. Silver Lake raised its bid to its current value of $13.65 per share on Feb. 4. After meeting throughout the day, Dell’s board finalized the merger agreement and announced its plans the next morning. During the subsequent go-shop process, its advisors contacted 67 parties, including 19 potential strategic bidders, 18 financial sponsors and 30 others, including sovereign wealth funds. Four others expressed interest unsolicited. Out of this process, 3 proposals were received. The Board has decided to continue negotiations with Blackstone and Icahn.

The Blackstone proposal gives shareholders two options: cash out or stay in. Those that cash out will receive $14.25 per share. Those who decide to stay in will receive shares "valued in excess of $14.25." Carl Icahn's offer would also keep the company public. He is offering to buy as much as 58.1 percent of the stock at $15 per share. Michael Dell is allegedly now saying that he will support a Blackstone buyout if he remains the company's CEO. An insider told Bloomberg that the company's founder is in ongoing negotiations with Blackstone. Blackstone is unlikely to go hostile on the company and try to acquire it against the wishes of the CEO. Blackstone is a buy-out expert, not a technology player. The industry is at a stage of its development where the best strategy to preserve company’s future is not obvious, fighting the company’s CEO may compound the risks unnecessarily. I can imagine, though, Silver Lake and Blackstone groups coming together in one consortium with the CEO. It is less likely that Carl Icahn would actually take over the company. His presence will, however, till the last minute pressure the private equity firms and the eponymous CEO himself, to maximize the price they will pay the shareholders.

Dell fell less than 1 percent to $14.33 at the close in New York on March 28, last day of trading before Easter, 5 percent above Michael Dell’s offer. The market clearly believes Silver Lake and Blackstone can and will sweeten their offers but it also thinks Mr. Icahn is bluffing.

A big question for public shareholders in this LBO is to ensure its terms are fair as Mr Dell’s dual role as a CEO and shareholder may create a genuine conflict of interest. Would shareholders benefit by selling their shares at a price at which the CEO is willing to buy?