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The Ins and Outs of the Dell Buyout

By Chad Fraser on February 6, 2013

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Dell Inc. (NasdaqGS: DELL) is going private. Yesterday, the company signed a deal to be acquired by founder Michael Dell in partnership with private-equity firm Silver Lake Partners.

Under the $24.4-billion Dell buyout, shareholders will receive $13.65 in cash for each share they hold. The purchase price is represents a 25% premium over the stock’s closing price on January 11, the day rumors of the buyout began to surface in the press.

The Dell buyout is subject to a 45-day period in which the company will solicit other bids. If another offer is successful within that period, the purchaser would have to pay a $180-million break fee (or $450 million for offers outside that period). Dell shares are currently trading at $13.42, which is below the partnership’s offer. That’s a sign that investors aren’t counting on a better deal emerging.

How the Dell Buyout Works

The transaction is the largest leveraged buyout (LBO) since the financial crisis. Under a leveraged buyout, purchasers use a company’s asset value to finance most of the debt they take out to take it over; right now, Dell’s market cap (or the value of all its outstanding shares) is around $23.3 billion.

Founder Michael Dell is putting forward his 14% stake in the company, plus a cash contribution, Silver Lake is thought to be contributing around $1 billion, and an estimated $15 billion of the Dell buyout will be financed by loans from major banks, including Bank of America (NYSE: BA), Barclays plc (NYSE: BCS), Credit Suisse Group (NYSE: CS) and RBC Capital Markets. Microsoft (NYSE: MSFT) is also loaning the company $2 billion. More on that below.

Michael Dell will remain the company’s chairman and CEO. Shareholders and regulators must still approve the Dell buyout, but the partners expect the transaction to close before the end of Dell’s fiscal 2014 second quarter.

Dell Buyout: Microsoft Guards Its Turf

The move comes as Dell and other PC makers, including Hewlett-Packard (NYSE: HPQ) fight against the trend toward mobile devices, which many users are favoring over personal computers and laptops. As the Associated Press reported, PC sales fell 3.5% last year, according to the latest figures from research firm Gartner Inc. That’s the first decline in more than a decade. Making matters worse for PC makers is the fact that tablet computer sales are expected to top those of PCs this year.

Meantime, Dell reported an 11% revenue decline in its fiscal 2013 third quarter, which ended November 2, 2012, to $13.7 billion from $15.4 billion a year ago. Net income plunged 47%, to $0.27 a share from $0.49. Excluding certain non-recurring items, Dell earned $0.39 a share, down 28% from $0.54. Dell missed the consensus forecast on both the top and bottom lines: analysts expected $0.40 a share in profits on revenue of $13.9 billion.

In all, the stock has plunged 24% over the past 12 months, from around $17.65 to today’s level.

The launch of Microsoft’s new Windows 8 operating system in October was thought to be a tailwind for Dell. The PC maker reports results for the current quarter on February 19, so we should get a sense of Windows 8’s impact then, but so far indications are that the new system’s sales have been impressive but not quite in home run territory: roughly 60 million licenses have been sold through the first 90 days, according to Microsoft CMO and CFO Tami Reller, which is on par with Windows 7’s debut.

Microsoft’s involvement in the Dell buyout is largely seen as a defensive move, as the company aims to keep device makers like Dell from experimenting with other operating systems, like Google’s (NasdaqGS) Android OS.

“Microsoft has provided a $2 billion loan to the group that has proposed to take Dell private,” said the software giant in a brief explaining its move. “Microsoft is committed to the long-term success of the entire PC ecosystem and invests heavily in a variety of ways to build that ecosystem for the future.”

That had Business Insider writer Jay Yarow asking how far Microsoft is willing to go to keep control of its ecosystem. Would it, for example, look at bailing out struggling Hewlett-Packard, as well? In its explanation, Microsoft hinted that such a move wouldn’t necessarily be out of the question:

“We’re in an industry that is constantly evolving. As always, we will continue to look for opportunities to support partners who are committed to innovating and driving business for their devices and services built on the Microsoft platform.”

Either way, Microsoft’s assistance of Dell, along with its own move into hardware with the Microsoft Surface tablet computer, will do little to endear it to competing hardware makers who support Windows.

Options Could Be Limited

The key question now is what Michael Dell has in store for the company once he pulls it out from under the market’s scrutiny. He’s already been at the helm for five years since he returned to lead it in 2007 after stepping down in 2004. It seems likely that Dell will continue to follow its current strategy of shifting toward selling more servers and computer services, a model used to great effect by International Business Machines (NYSE: IBM).

To speed up its turnaround, the company will likely look at making acquisitions—web hosting firm Rackspace (NYSE: RAX) has been a rumored target in the cloud computing area—but going private could make such moves harder to make, largely because of Dell’s increased debt load.

As we don’t yet know all the details of the transaction, it’s hard to pin down exactly how much debt the transaction will add to Dell’ balance sheet, but Dave Novosel, senior credit analyst with Gimme Credit in Chicago, estimated in a Wall Street Journal article that the company’s total debt could rise to around $19 billion from today’s level of roughly $9.0 billion (including short- and long-term borrowings). Novosel also estimates debt-servicing costs of about half a billion a year, after tax.

In that scenario, it’s hard to imagine how Dell could acquire a company like Rackspace, which has a market cap of around $10.4 billion.

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  1. avatar
    ROBERT HENDERSON Reply February 9, 2013 at 10:18 AM EST

    o k