One Shareholder Won't Let Dell Go Without Putting Up A Fight

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:

Net cash per share after deducting structured debt within Dell Financial Services (DFS) is $3.64. Dell Financial Services has a book value of $1.72 per share. In addition, since Michael Dell resumed his role as CEO in 2007, the Company has spent $13.7 billion or $7.58 per share on acquisitions intended to transform the Company into a sustainable IT business and lessen its reliance on the PC business. During Dell’s June 2012 analyst day, Dell Chief Financial Officer Brian Gladden said that in aggregate the acquisitions to that point had delivered a 15% internal rate of return. The Company has neither taken nor discussed the need to take any write downs of these acquisitions. We therefore conservatively believe the acquisitions are worth a minimum of their cost. Taken together, these items total $12.94 per share before we even look at the other businesses.

That sounds boring but it strikes me as having quite an edge; Southeastern is effectively saying:

• Either this deal values Dell's PC business at less than 71 cents per share, a suspiciously low number,3
• Or, Dell has not been particularly forthcoming with the market in its prior statements and its financials: the value reflected on its books for its acquisitions, cash, and/or financial services business was too high.4

Neither seems like a very palatable thing for Dell's board to agree with.

So that creates some awkwardness, but awkwardness doesn't really move the needle for Southeastern. So what's their practical solution? Here's one option:

We understand that Michael Dell is not bound to the Silver Lake transaction and can participate in facilitating a superior offer. We are concerned that given the participation of Michael Dell in this transaction, that a traditional go shop process is not sufficient to ensure that the Company receives superior offers. Specifically, as stated above, our value for the entire Company is approximately $24.00 per share, but we also believe that selling multiple business units to strategic buyers could easily exceed $13.65 per share.

The piecemeal sale idea seems a bit like the dividend recap, in that (1) it would have worked better a week ago and (2) the fact that the board entered into this LBO agreement suggests that no particularly worthwhile piecemeal sale was on the table. Still, who knows, maybe Evercore, Dell's go-shop bankers, will go out and earn their fee by finding buyers for bits of Dell that deliver more than $13.65 per share in aggregate. I guess?5

This struck me as the most interesting idea though:

Additionally, the Board of Directors should aggressively seek a proposal that differs from Silver Lake’s thereby not forcing public shareholders to sell for a price so far below a reasonable valutation. A different buyer could serve the same purpose as Silver Lake, undertake similar leverage, but importantly and more fairly, could allow a reasonable percentage of the “rolled-in” equity to come from existing shareholders who choose to do so. While functioning much like a typical private equity transaction, this would actually leave a public “stub,” which would allow public shareholders to remain investors in Dell’s future. Several previous transactions have successfully implemented this type of structure and it merits study by the Board of Directors.

This is indeed a thing that happens, and it might be Southeastern's best bet: between its threats to vote no, the various lawsuits already aimed about the deal, and the public/shareholder-relations headache of Southeastern's very public fight, you could juuuuuuust about imagine the buyout group agreeing to a deal that gives public shareholders the chance to remain in a Harman-style public stub. Though the fact that the buyout group asked Microsoft for debt, rather than equity, financing suggests that they're not that keen on giving out equity in the new company to just anyone.

Or something else? If I were a hedge fund manager unhappy at being forced into being a seller at $13.65, I might try to be a buyer at $13.65, or $13.75. The merger agreement (section 5.13) lets Silver Lake et al. syndicate some of the LBO equity either to its LPs or, with Dell's consent, to anyone else. Letting Southeastern roll over some of its shares into the LBO company would be one way to gain their support without opening that equity up to everyone. (And if they're willing to roll over at a lower valuation, i.e. buy at a higher one, that could free up more cash to pay a higher price to the rest of the public, making it a win for everyone.) Sadly that does not seem to be Southeastern's game - they're pretty public-equity-only - and in any case their 153mm+ shares, at $13.65 a share, would be hard to fit into an LBO with only $2bn and change in equity.

So, I dunno. I don't have high hopes for Southeastern making much of a difference here, though what do I know. Mostly just venting, I guess? With perhaps a dim hope that this venting, plus the usual lawsuits, might spark a small price increase. Which is something, though I wouldn't hold my breath for $20.

Southeastern Asset Management Schedule 13D [EDGAR]
Dell shareholder Southeastern unhappy with buyout [Reuters]
Dell’s Biggest Independent Shareholder Opposes Buyout [MarketBeat]
How Dell Tried to Avoid Potential Buyout Pitfalls [DealBook]

1.Though an awkward Schedule II to the 13D shows that Southeastern has been a seller of several hundred thousand shares at $13.46 over the last two days. "Sales by Southeastern at the direction of a client in the ordinary course of business on NASDAQ or through Electronic Communication Networks (ECNs)" though; Southeastern's holdings are partially in Longleaf, its pooled fund, and partly in separately managed accounts some of whom seem to want out.

2.Relevant: can you create value by financial engineering? Minds ranging from Modigliani & Miller to Einhorn & Blodget have pondered this very question. Learn from their wisdom!

3.WHICH: good glaven, I've owned Dell PCs. Zero is too high.

4.In fact it's stronger than that when you note the CFO's quote about a 15% IRR on the $7.58/share of acquisitions over the last five years. Assuming that the weighted average age of those acquisitions is 2 years, then they should be worth ~$10 per share now; add the cash and DFS and you get a value north of $15 based just on the company's public statements. Unless those statements were ... wrong?

5.The merger agreement (section 5.4(h)) would appear to allow Evercore to solicit only proposals to buy more than 20% of Dell. So, a chunky breakup.