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. Read more »
Two ideas at the heart of modern financial economics are the efficient markets hypothesis, which says that investing doesn’t work, and the Modigliani-Miller theorem, which says that corporate finance doesn’t work.1 Also there is a financial industry which is pretty much organized around ignoring those ideas. Hahaha how stupid of David Einhorn to think that he could make Apple more valuable just by issuing some preferred stock! But also how stupid of David Einhorn to think he should invest in Apple rather than a market-cap weighted index of all the companies! I mean, stock picking, so last century, just index.
Management buyouts are one place where those two efficiency hypotheses break down in obvious ways. Of course management knows more about a company’s prospects than public shareholders do, and so will be able to buy when the company is undervalued.2 And of course adding giant gobs of debt to the balance sheet, with the attendant tax benefits, will make the stock more valuable. This doesn’t always work out – managements have their own problems estimating their company’s prospects, and leverage is risky – but it’s a perfectly plausible theory.
Or so I think but I come from a corporate finance background. Neil Irwin is an economics guy so he is puzzled: Read more »
Today Southeastern Asset Management, which is Dell’s biggest shareholder that doesn’t share a name with it, expressed its displeasure with the company’s $13.65-a-share LBO today in the form of a letter to the board patiently explaining that:
Dell is worth $23.72 a share, and
Dell could pay $11.86 a share in cash in the form of a special dividend and still be a decent standalone company with over $1.14 of FCF per share, and
Can’t we work something out?
Southeastern appears to have a basis in Dell north of $20, so, y’know, they would say that Dell is worth more than $13.65.1 But: who cares? Southeastern gets a vote like everyone else does; the merger agreement requires a majority of the non-Michael-Dell shareholders to approve the deal but preliminary nose-counting suggests that, between index funds and merger arbs and others not anchored in the $20s, they’ll probably get there.
What is Southeastern up to? Their proposed dividend-recap solution, in which a standalone Dell would increase its shareholder value through the magic of financial engineering, may or may not work,2 but that’s mostly irrelevant: it’s hard to imagine the board changing its mind now and deciding that standalone engineering is superior to this LBO. For one thing: that is the sort of thing that boards obviously consider before agreeing to an LBO, so presumably they had a reason for rejecting it. For another: if Dell decides now, as opposed to last week, that a dividend recap is the way to go, it’ll owe Silver Lake $450mm in termination fees. That’s the sort of expensive change of heart that makes a board look really bad – and that alone is reason enough to be pretty sure that idea will never fly.
Which is not to say Southeastern doesn’t score some good points. I was moved by this: Read more »
The Dell deal documents are out and they are short of juicy details; we’ll have to wait for the proxy for details on things like just how much of a discount Michael Dell is taking on his shares or what exactly the terms of Microsoft’s loan are. There is, though, the information that that loan will take the form of $2 billion of subordinated debt, and that the total cash equity investments from Silver Lake, Michael Dell and MSD will total $2.25bn. This seems pretty sensible; Microsoft is effectively writing half of the equity check, though for a fixed-but-subordinated return, plus emotional benefits or what have you. And if you’re worried about how easily debt markets will swallow some $3.25bn of bonds, $5.5bn of Term B/C, and billions of assorted other secured financing,1 which with $4bn of existing bonds brings Dell to around 4x total leverage, making $2 billion – almost half a turn – of the debt subordinated, long-term, and emotionally committed can’t hurt.
But for most of the fun stuff we’ll have to look forward to the proxy. And that isn’t good enough for some people. Reuters reports that the first shareholder lawsuit over the deal has already been filed, one day after announcement, which I assume means it was in the works before the deal was announced. This sort of amazed me: Read more »