February 12, 2013

Michael Dell Will Not Steal Dell After All...What Will Dell Become?


Today we have a tale of two stories - Michael Dell's attempt to take Dell private for what more or less amounts to a song and a dance and whether he can or not, and what exactly is to become of Dell the company should it go private. Let's look at the first issue, and then consider the second.

Last week, when we covered the announcement that Dell is attempting to go private, we wrote that the deal wasn't necessarily a done deal yet:

Technically the Dell board has indeed "closed a buyout" but shareholders will need to vote with their shares - will they take $13.65 a share or will they feel they are being shafted? Michael Dell himself is contributing his entire 16 percent stake in Dell towards the deal but he ends up essentially owning the entire company.

As we had anticipated when we wrote the above, some investors, among them the largest outside investor not named Michael Dell - Southeastern Asset Management, which owns about 8.5 percent of Dell, are not quite ready to go along with the deal. Southeastern has taken a highly vocal and negative stance on the deal, and has made it clear it will not vote its shares in favor of the buyout at the offered price.

According to the Wall Street Journal, "A person familiar with the matter estimated that Southeastern paid an average price for Dell of about $16.90." Southeastern stands to book a loss likely in the range of $250 to $350 million at $13.65 per share. Southeastern filed a detailed report with the SEC on Friday and sent a letter to the Dell board that makes the case for Dell being valued at $24 per share (even though the shares haven't seen that price since 2008). So what's real? Suffice it to say, it will likely become a case of sweetening the deal for Dell and his investors, probably to $14 a share or a bit more.

Dell and his group have, of course, delivered a lowball offer in the guise of a substantial premium. Southeastern has now, of course, fired back with the highest possible price Dell could deliver on. Neither price is real or the bottom line, and following what we anticipate will be significant public posturing on both sides, we believe we'll see a compromise position emerge.

It all hinges on which side can muster the requisite shareholder allies - Dell and his cohorts, or Southeastern and other disgruntled shareholders. Southeastern also believes there are other more attractive options for shareholders than a buyout - such as a one-time dividend funded with Dell's cash and some debt, or a buyout arrangement that offers current shareholders an opportunity to participate in the deal. Dell's board claims it investigated such options and determined them to be less valuable than the buyout offer. Southeastern may indeed be after getting in on the leveraged buyout itself in that it would keep its money and position in play, possibly for a future IPO.

Analyst Toni Sacconaghi of Sanford C. Bernstein, again according to the Wall Street Journal, estimates that more than 20 percent of outstanding shares are now in the hands of merger-arbitrage traders, who Sacconaghi says will benefit from the deal. That 20 percent is a major block that would more than likely align with Dell and not with Southeastern. On the other hand, S&P Capital IQ notes that approximately 58 percent of shares are held by investment funds such as T. Rowe Price and BlackRock - we find it hard to believe they are happy with the offer on the table. About 11.7 percent of outstanding shares are held by investment banks and hedge funds.

What do those players on the fence need to consider?

What Will Dell Do?

The problem with Dell is that it is now suffering the first stages of "Microsoftitis" - a financial disease and condition wherein a company's stock remains stuck in the same tight range for over a decade. As does Microsoft, Dell has a number of businesses it operates in that generate significant revenue - certainly enough of it to keep the company entrenched in a Fortune 50 or Fortune 100 position for many years to come. And as does Microsoft, these are all long-time and now entrenched enterprise businesses that have absolutely no worth to Dell from a marketing position. It cannot create any enthusiasm from these businesses.

As has Microsoft for many years, Dell has failed to capitalize on either mobile trends or the consumerization of IT technology (BYOD and so on). In fact, Dell's stumbles here make Microsoft's own feeble efforts look good, a rather powerful indictment of Dell's failure to capture the consumer imagination (by which we mean both the workforce as consumer and the pure consumer market). Dell's stock has now settled into a very small range around which nothing is likely to move it. It makes too much money for the stock to really be hit hard, but it offers absolutely nothing that will jump start the investor community to get on board and drive the share price up - as we said, Microsoftitis.

Microsoft has finally begun to show off a better mobile game, but the irony is that Microsoft's mobile A game is arriving just as the consumerization of IT wave and marketing hype may be waning - meaning that Microsoft will end up grabbing lots of enterprise mobile share and billions of new dollars but without the necessary fanfare to drive the stock price up. It is an amazing phenomenon - Microsoft is the most successful enterprise company to ever be seen as a failure!

We need to add in to the mix for Dell that there is no doubt the PC business itself is also waning, and regardless of its different business lines and revenue streams Dell is still perceived to be a PC company. So in addition to having failed to get on the mobile next wave the company is now perceived to be eyeball deep in a declining market. It is an extremely tough and formidable double edged sword Dell is fighting against.

But give Michael Dell credit - not only has he seen that Dell is infected with Microsoftitis, he has also seen that there is a great opportunity here to take Dell the company back at a great price - $24.4 billion is a bargain. With a private company in hand and minus the huge distractions and very limited flexibility that go hand in hand with a flailing public company, Michael Dell would have a far easier path to "trying" to rebuild Dell the company, resizing Dell's PC business for a declining market, and perhaps finding a way to bring some real innovation to the market.

Dell could sell off its hardware businesses - yes, even the direct PC business (though even a private Dell won't do that), shore itself up with tons of cash, perhaps buy a consulting company and become the IBM or Cap Gemini of the small business world. It can continue to build up its cloud services - and a Dell cloud offering for SMBs would prove quite attractive and offer SMBs a safe harbor to move into the cloud space. As a private company it would also be able to better build an internal skunk-works environment where it might have a better shot at turning out new products that might appeal to both the "workforce as consumer" and the true consumer.

There are a number of such options available for a private Dell to pursue in the peace and quiet of being privately held. However, that said we also need to note that one of the causes of Microsoftitis is Steve Ballmer himself - a great COO, but not a CEO for the times we live in. Dell may be only 47 (Ballmer is nearer to 57) but he's also lived a lifetime in the delivery of primarily enterprise products - whether he can transition to and succeed within the times we live in is a real risk and a gamble.

Ultimately, the real payoff for Dell - and especially his fellow investors - would be to position the private Dell to go through another IPO. Southeastern no doubt sees that as the real way to unlock real future value out of its current underwater investment. That precludes an analysis of whether or not Dell will have too big a debt load and not enough revenue as a private company to manage that debt. If the declining PC market goes through a tsunami-level drop - meaning significantly less revenue than a private Dell anticipates, Dell may not survive going private. Going private doesn't magically relieve Dell of having to earn its keep.

Yesterday, Today and Tomorrow

Given Dell's current lines of business and the ways it earns its revenue, and given its failure to successfully find ways to tap into today's markets, the stock will not recover. Yesterday's $24 per share Southeastern suggests is the real value of Dell is a pipedream.

If the leveraged buyout fails to materialize and the company remains public, it's possible if not likely that the stock will fall back to the $10 range, further aggravating the scale of losses for current larger investors (small investors suffer as well of course, but they aren't going to influence what happens with Dell). Dell's team can then simply return to the table with perhaps an even lower offer. At a lower price point however, other suitors may emerge that would possibly lock Dell himself out of ultimately owning the company.

However, as long as there is a possibility for the deal to go forward today, investors can expect $13.65 per share to remain the lower boundary on pricing. Southeastern doesn't hold the best cards to create more value for itself, but the hand it has is strong enough to continue playing. It doesn't have anything more to lose and potentially it can land a better deal. For Dell and his team they may hold the better hand but they have much more to lose if they misplay it. To us that spells out "compromise."

It will be very interesting to see how it ultimately plays out tomorrow. Our guess is $17+ per share - a fair price considering that Dell himself has led the company to its current state of affairs. He shouldn't be able to profit so boldly for his complete failure to move the company forward and deliver greater shareholder value in the first place.






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