Monday, August 5, 2013

Sunday Night Scotch: Do I see Checkmate? Did Michael just win?

So, the big news going into the weekend was the outcome of the latest round of negotiations between the Silver Lake/MSD team and Dell's buyout committee, as Arik Hesseldahl notes in the Wall Street Journal:

Michael Dell and Silver Lake Reach Last-Minute Buyout Deal

People have constantly hit me up for insight that I could not provide in this situation. Now that I am free of any financial interest in the transaction and I am truly a spectator,  I must say I am having fun watching this. The truth is that even the execs inside of Dell were pretty much in the dark about the machinations surrounding "the transaction". I can honestly say that anything I type here is strictly a thought manufactured by my own brain, and publicly available information. It's also my own opinion. You get what you pay for... so let's pour ourselves a good single malt and walk through the data, shall we?

As described in the referenced article, Silver Lake et al. have basically raised their bid to $13.96 per share for all the outstanding shares of the company.  As you know, the rival bid is an enigmatic $14 per share for some fraction of the company. Carl Icahn, while quite noisy, really hasn't done a lot to put a credible offer on the table. At that price, he is willing to buy some unspecified number of shares, depending on who wants to sell. I'm sure he is serious about what he says, but his actions betray what appear to be a set of short term profit goals. (I am not going to go into the game theory of what happens if everyone wants to tender at $14 and he only has the money for some fraction of the shares... could happen, though). Suffice it to say, it looks like MSD is winning right now: $13.96 per share in cash vs. something... umm... close to that, in the case of Icahn.

All of that is a distraction to what is really going on: You have a $60 billion+ revenue stream with a substantial part of it in a state of secular decline - and you have this "going private" thing. So here's my shocking opinion: This has nothing to do with going private. This is about WHAT gets done to fix it, and, of course, WHO profits from a successful outcome. MSD and company think that this is not for widows and orphans. In essence, they are saying, "If you have no risk tolerance, you better get off now. Here's some cash.".  For reasons I will outline shortly, I believe that they are very right about this.

On the other guard rail, you see Carl Icahn pounding the table that you are all being ripped off. Well, he is right, too: If all of us were comfortable with the set of risks involved with this sort of turnaround, and it turned out to be successful, he is absolutely correct. That is a very bad assumption, though. Widows and orphans do not invest in high risk leveraged turnarounds. Carl Icahn does. Enough said.

As for the deal itself, it is not very hard to run the discounted cash flow analysis yourself and figure out what the whole thing might be worth. In this article, Chris Nichols provides a nice model for you to play with. Just click here for the spreadsheet and run your numbers. Hint: It all hinges on what the profit margins are of the future entity. If you believe, as he does, that this is just a PC client company with 17% gross margins, then the current offer is a fair price. If, on the other hand, you believe that the current margins in excess of 20% are sustainable and can grow higher, then it is easy to see how money can be made from the deal. It is all about what you believe, and whether you think the rewards are worth it. Would you take a crazy risk for a 100% return? Do you need a higher return than that to justify the risk? What is the likelihood of a higher payout? If Icahn is so sure, why doesn't he just buy the whole company instead bringing along the widows and orphans? As you can see, this is not easy stuff to think through.

In the end, the real issue is the WHO part of the above equation. Is it MSD or Icahn who will get the better outcome and reap its benefits? In my short experience trying to raise venture money for my own company, I have a hunch that the guy whose name is on the door has the right motivation. I do not know that he has the gumption to make all the right decisions, but frankly, I cannot see how the current sole alternative will result in a more profitable outcome. Moreover, unless a better, more credible offer is in the works, the best hope for the dissidents is to try to somehow get folded into an equity stake in the private entity. After all, they seem to talk like they have the risk tolerance for it. In a private Dell, they may be able to structure themselves a deal where they get a lot better than a 100% return. Who knows what happens this week...

Disclaimer: This is just my opinion. Have fun with it, but don't try to tell me that I know anything you couldn't have figured out yourself.  

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