I learned a new word, or word-like sequence of letters, reading the Dell merger proxy this weekend. The word is “must-believe,” and it’s a noun meaning a thing you must believe in order to embark on a certain course of action. You don’t have to believe a must-believe, but if you don’t believe it you shouldn’t do the thing that it’s a must-believe for. There are no prizes for guessing that I learned it from a management consulting deck.1
What are the must-believes for selling Dell to its CEO, Michael Dell, and his private equity sponsors at Silver Lake? Well, here is a must-not-believe, from JPMorgan’s fairness presentation to Dell’s board:2
The dotted box on your right floats rather far above the red line of Silver Lake’s offer: if you’re the board, and you are deciding to sell Dell to Silver Lake for $13.65 a share, you must not believe that Dell’s management is telling you the truth about its projections or that it is competent to achieve them. Because even at the low end of those projections (from September 21, 2012), Dell is worth at least $15.50 a share.
Of course the Dell board didn’t believe management’s projections – as JPMorgan says in that footnote, “Based on discussions with the Special Committee and BCG, as well as the recent history of management’s failure to achieve its forecasts, we understand that the 9/21 management forecast is aspirational in nature.” To be fair JPMorgan encouraged that viewpoint; from the proxy:
On November 16, 2012, J.P. Morgan provided the Special Committee with charts showing that the Company’s revenue for each of its prior seven fiscal quarters had been below both management’s budget and, with the exception of one quarter, consensus analyst estimates, while the Company’s earnings per share performance had been mixed as compared to management’s budget and consensus analyst estimates.3
That’s why the BCG case is there in the first place: the board thought that management was so bad at predicting its performance that it hired the Boston Consulting Group to predict its performance for it. And while BCG’s base-case projections were in line with the Street and way below management’s, they also discussed a variety of operational improvements – which the JPMorgan deck misleadingly calls “restructuring”; Evercore more accurately calls it the “productivity case” – that also, if they were implemented with 75% success, would make Dell worth at least $15 a share. These were improvements proposed by management, revolving around cost efficiency (including “Sourcing in China/labor arbitrage”), growing emerging-market share, and improving sales force effectiveness.
BCG handicapped their probability of success and ultimately concluded the were worth at least $2.20 per share. And they have a certain amount in common with Michael Dell and Silver Lake’s plans for Dell post-LBO, including sales-force improvements, a focus on emerging markets, and simplification of customer options, though the post-LBO plans are more investment-y and less efficiency-y than the consultants’ plans.
Overall, though, the board definitely could have concluded that there was a future for Dell as a public company, and that that future was worth more than $13.65 per share. But it didn’t. Why not? Here is Michael Dell’s argument:
He outlined [in a December 6 board meeting] strategic initiatives he would cause the Company to pursue as a private company, including (i) extending the Company’s ESS capabilities through significant investments in research and development and additional acquisitions, (ii) hiring large numbers of additional sales personnel, (iii) expanding in emerging markets and (iv) investing in the PC and tablet business. Mr. Dell stated his belief that such initiatives, if undertaken as a public company, would be poorly received by the stock market because they would reduce near-term profitability, raise operating expenses and capital expenditures, and involve significant risk. … Mr. Dell reiterated his belief that implementing such initiatives would require additional investments that could weaken earnings and cause greater volatility in the performance of the Common Stock. Mr. Dell also noted that, in the absence of a transaction, he would be prepared to stay on as Chief Executive Officer and attempt to implement certain of these initiatives despite the increased risks he identified.
So … if Dell tried to implement Michael Dell’s plan while still public, it would run the risk of missing analysts’ expectations, as it had done pretty consistently for the last seven quarters. And that would somehow drive it to go private or something.4
Here’s BCG’s argument:
The Special Committee discussed with BCG [at a January 2 meeting] the extent to which the Company, if it continued as a public company, could take the actions required to implement these strategic initiatives and whether changes to management would be necessary in order to do so. BCG expressed the view that, although the Company could attempt to implement these initiatives as a public company, there would be risks and challenges to doing so, including the challenges associated with the ability of current management to execute this plan and the negative impact the initiatives could have on the Company’s near term financial condition and the possibility that the Company’s relationships with existing customers and vendors would deteriorate as the Company transitioned to other businesses. BCG also noted that even though the Company had used $11.4 billion of the Company’s cash resources over the previous four years to fund acquisitions in its ESS [enterprise solutions and services] business and devoted a significant amount of management time and attention to expanding the ESS business, the EUC [end-user computing] and EUC-driven businesses remained the source of approximately 65% of the Company’s revenue.
So … if Dell tried to implement Michael Dell’s plan while still public, it would run into the problem that Dell’s management are a bunch of incompetents and have spent the last four years and $11 billion of acquisition dollars pursuing the move to higher-margin enterprise businesses without much to show for it.5 Aswath Damodaran wrote about the Dell deal a while back and was unimpressed by that argument:
The same management that made those mistakes now wants to buy the company at a lower price that they, in a sense, caused. That looks to me like rewarding management for a job badly done. Furthermore, for the last few years, Michael Dell has been telling stockholders that these were not mistakes (and were making healthy returns).
That seems true, no? Dell’s management and board were overly optimistic when it came to making acquisitions, which seem to have been largely wasteful.6 And now they’re strangely pessimistic when it comes to selling the company.
Not all of them. Among my favorite moments in the proxy is this, from after the deal was announced:
On March 7, 2013, the Board held an in-person meeting at which representatives of Debevoise were present. During the meeting, [CFO Brian] Gladden presented proposed final versions of the Internal Plan and the Board Case for fiscal year 2014 to the Board …. Following Mr. Gladden’s presentation, members of the Board raised concerns about the increase in projected revenue contained in the Board Case as compared to the Preliminary FY14 Board Case, as well as the achievability of the projections in the Board Case more generally. At the meeting, it was decided that Mr. Gladden should work with Shantanu Narayen, the chair of the Leadership Development and Compensation Committee, to consider more conservative sensitivities and develop a final proposal for the Board Case for fiscal year 2014. Thereafter, management presented a more conservative version of the Board Case. The Internal Plan as presented at the March 7, 2013 meeting and the Board Case as revised after that meeting were approved by the Board by unanimous written consent as of March 20, 2013.
Can you imagine? The board decides that management’s September financial plan is too optimistic, commissions a more pessimistic financial plan, approves an LBO based on that more pessimistic plan, announces the deal, gets lots of pushback, and then … the dumbass CFO presents an even more optimistic management plan? “Oh hey guys, I know you signed up that LBO based on our shitty prospects, but turns out 2014 will be GREAT!” How does that look? Bad enough for the board to say “ARE YOU SURE ABOUT THIS PLAN HINT HINT HINT MAYBE WORK WITH SHANTANU FOR A BIT AND SEE WHAT YOU COME UP WITH,” apparently.
The whole proxy, and its pile of gloomy board books from Dell’s financial advisors and consultants, make for riveting, horrible reading; no one comes off well and you can suspect anyone and everyone of laziness,7 cowardice, incompetence and self-dealing if that’s your thing.8
But … is the LBO a good deal? I don’t know. You can tell that Dell’s special committee did its best to get Silver Lake’s highest price, though you also get the pretty strong sense that it was disappointed with that price.9 And the process for getting competing bids, both before and after the deal was announced, seems to have been thorough and thoughtful.
But the process for finding a non-sale alternative, in which Dell makes another go of it as a public company, is a bit less fleshed out. For instance, for all of Dell’s protestations that they’d given serious thought to a leveraged recap, they only seem to have considered cash returns in the $2-$5bn range, well below Southeastern’s $21 billion or Carl Icahn’s $15.65 billion. The pretty modest recap proposals seem to have been limited by the desires to preserve Dell’s investment-grade rating and not use tax-inefficient offshore cash – both objectives that were abandoned in the LBO.10 And you get the sneaking suspicion that BCG was hired, not to figure out how to turn Dell around, but rather to justify ignoring management’s optimism. After reading the proxy, I was left with a sense that the board had given up on Dell as a public company. And, after reading the proxy, I can’t really blame them.
Dell Preliminary Proxy Statement [EDGAR]
Dell 13E-3 and exhibits [EDGAR]
Dell Amendment No. 1 to Schedule 13E-3 and exhibits [EDGAR]
Dell: We’ve got 99 problems but the bid ain’t one [Fortune]
What Dell Thought of Alternatives to the Silver Lake Proposal [DealBook]
1. Just let slide 6 here wash over you. The must-believes include “separation creates minimal dis-synergies,” which is a problem because “common sales team key enabler of strategy.” I miss corporate life sometimes.
2. Evercore also did a fairness opinion; the proxy says, somewhat magically, that “Evercore performed, for reference and informational purposes only, a discounted cash flow analysis of the Company.” So the valuation of the company wasn’t used in reaching its fairness opinion? “Oh, we wanted the analysts to have practice doing the sort of analyses we’d do for a real merger, so we had them do a DCF even though we didn’t use it in our fairness opinion.”
3. It’s almost as though JPMorgan wanted Dell to sell? Also from the proxy:
J.P. Morgan has acted as financial advisor to the Special Committee with respect to the merger, and will receive a transaction fee from the Company for its services of approximately $35 million, $2 million of which was earned upon execution of its engagement letter [on September 11, 2012], $3 million of which was earned upon the public announcement of the merger agreement, and the rest of which will become payable upon the closing of the merger.
Also Goldman Sachs, the company’s investment bank, had its own doubts about those September 21 projections; it noted that “The revenue growth rate and operating margin assumptions in the 9/21 Case financial projections would need to be meaningfully reduced in order to arrive at illustrative DCF values that are more in line with [Dell's] current share price.” One way of saying that is “the stock price doesn’t reflect our prospects,” but you can only say it that way if you think that management’s understanding of its prospects is plausible.
4. In the “Reasons for the Merger” Dell gives a more nuanced version of this, characterizing it as “the Special Committee’s belief that the Company’s failure to achieve forecasted revenue and earnings per share in recent fiscal quarters had undermined investors’ and analysts’ confidence in the Company’s management, to the detriment of the Company’s ability to execute long-term strategic plans that, in the short term, may not increase, or may have a negative effect on, revenue, expenses or earnings per share, as well as the likely customer reaction to the public execution of such long-term plans.”
5. BCG are pretty mild-mannered about it, but they note in their discussion of Dell’s culture a “History of optimism, weak forecasting and planning” as well as the anodyne “Acquisitions bring different business models and beliefs.” Apparently at the meeting where they presented that deck BCG “also noted that the Company was still in the process of integrating its numerous recent acquisitions and that these acquisitions had yielded lower returns to date relative to the returns expected by the Company’s management.”
6. As Southeastern has pointed out.
7. Except of course the lawyers: “Following the adjournment of the Board meeting, representatives of Debevoise, Simpson Thacher and Wachtell Lipton worked through the night of February 4 to finalize the transaction documentation.”
8. Another highlight: Southeastern originally proposed the deal, in June 2012. In Southeastern’s conception they’d get to roll their shares into the LBO company. As far as I can tell Michael Dell just forgot about this – in November he “stated that, while he had spoken in June and July with Southeastern about the potential for a going private transaction, he had not spoken with Southeastern about the possibility of such a transaction since that time” – and so missed his chance to get Southeastern onside. Later when specifically offered the chance to cut Southeastern in, Silver Lake and Michael Dell said no, but this seems like a weak bit of process management that they now probably regret.
9. There is a whole lot of blather like:
The Special Committee then directed J.P. Morgan to inform Silver Lake and Sponsor A that the Special Committee was dissatisfied with the price ranges and significant conditionality reflected in the preliminary non-binding proposals, and that the Special Committee’s willingness to allow Silver Lake and Sponsor A to continue in the process was predicated on their proposing transactions only at a materially higher price and with greater deal certainty.”
The illogic of that is self-evident, right? “Your bid is too low, and the only reason we’re letting you stick around and do more diligence is because you will later put in a much higher bid.” Later there’s like two pages of drama over the fight to move Silver Lake from $13.60 to $13.65.
10. For instance here is a JPMorgan October deck contemplating a $3.5bn buyback, limited by a desire to retain A-/BBB+ ratings. That’s not quite apples-to-apples with a BBish LBO.