Published January 15, 2013
With consumers increasingly shunning cumbersome PCs for sleek tablets and smartphones, it’s clear tech dinosaur Dell (DELL) is in need of a serious makeover, one that may not be possible under the harsh scrutiny of Wall Street.
That explains why Michael Dell is seriously considering allowing a pair of private-equity firms take his $22 billion company private in what would easily be the largest leveraged buyout since before the global economy tanked in 2008.
While a private-equity takeover would saddle the company with some $10 billion in debt, observers believe the move is justified by ridiculously low interest rates and the freedom to complete Dell's renovation from aging PC maker to modern IT company.
“If they can get out from underneath the massive amount of reporting and scrutiny a public company is under, it would make them much more agile and able to take the kind of risks Michael Dell would like to take to transform the company,” said Rob Enderle, principal analyst at the Enderle Group.
Enderle said it would be like trying to repair a race car that is still running rather than one that is resting quietly in the shop.
“The end goal would be to eventually take it public again. By that time it’s ready to race again,” he said.
Stumbling Dell Could Be Cheap
Despite some skepticism that a deal of this magnitude can be pulled off, since Friday’s close Dell’s shares have spiked as much as 21% to $13.20 on numerous reports indicating the company is in serious talks over a buyout with private-equity firms TPG Capital and Silver Lake.
Even with those gains, Dell’s stock has tumbled 28% since topping out at $18.36 in February 2012.
Once known for its made-to-order PCs, Dell has been pounded by Wall Street as it struggles to adapt to a new world where consumers prefer more portable devices like tablets and smartphones.
In November the company revealed a deeper-than-expected 47% slide in third-quarter profits, sending its stock plummeting as low as $8.69 -- their lowest level since March 2009.
At those depths, Dell was worth just three times projected 2013 EPS, a valuation Topeka Capital Markets analyst Brian White called “absurd” given the company’s net cash of $5.15 billion and steady free cash flow generation.
“Dell’s valuation has been and remains an insult,” White wrote in a note to clients on Tuesday.
Given this valuation, White believes “going private makes sense for Dell and its shareholders.”
Dell’s Declaration of Independence?
By selling to private-equity firms, Dell would escape the close scrutiny of analysts on Wall Street, potentially freeing the company to take the drastic steps that may eat into revenue.
Public-company status forces executives to focus “heavily on tactical quarterly returns and makes it almost impossible for them to make a major strategic change to the company,” said Enderle.
Regulations also make it difficult to explain to the markets the logic behind key decisions without simultaneously tipping off competitors.
Sometimes these distractions can backfire on management and shareholders alike.
Take Hewlett-Packard (HPQ), which has seen its stock plummet some 70% since April 2010.
H-P is “largely the story of a company that was trying too aggressively to please the traders. [Former CEO] Mark Hurd did a heck of a job of pleasing the stock analysts but ended up bleeding the company dry,” said Enderle.
Avoiding the ‘Microscope’
White said by going private, Dell can focus on completing its enterprise build out, which has been carried out to this point by aggressive acquisitions and organic growth. Dell’s sales from the PC market have tumbled to 48% as of last quarter, down from 67% in 2005.
“Getting Dell out from under the microscope is a good idea,” said White, who sees a price tag on a potential buyout of about $15 to $18 a share.
There are also heavy costs public companies must incur tied to regulations like Sarbanes-Oxley. Enderle estimates up to 20% of a company’s bottom line can be sapped by regulatory reporting requirements.
“Being a public company is expensive these days,” said David Becher, a professor at Drexel University.
But becoming a private company wouldn’t be cost free either.
Jefferies (JEF) analyst Peter Misek, who raised his price target on Dell to $13 from $10, told clients in a note on Tuesday that Dell would need to take on about $10 billion in debt in a leveraged buyout.
Can Dell Handle $10B of Debt?
The challenge for Dell would be to pay down that debt while simultaneously investing in the future.
While the company has a solid $14 billion in total cash, 90% of it is sitting overseas, making repatriation tricky from a tax perspective.
According to Thomson Reuters, Dell has a total debt-to-equity ratio of 0.89, which is far better than the S&P 500’s 1.58 ratio but above its industry group’s 0.78.
“They’re going to have to find cost savings elsewhere to offset this,” said Becher. Becoming a private company “could give them more flexibility and options but I don’t know that automatically improves their long term,” he said.
Still, Enderle said Dell “clearly” can handle $10 billion worth of debt, pointing to easy borrowing rates.
“It’s hard to believe [rates] could get any lower. If you were going to do it, now would be the time to make it happen,” he said.
All of this doesn’t mean a leveraged buyout of Dell is a done deal.
The biggest challenge will be finding enough capital to absorb the estimated $10 billion in financing and $5 billion in equity required for a deal of this size.
Jefferies said its leveraged finance desk sees $10 billion as the “upper bound due to the market’s ability to absorb that size rather than Dell’s leverage.”
“Doing an LBO at this scale for a healthy company is difficult because it’s just so expensive,” said Enderle. “This is nosebleed territory but with interest rates where they are, it’s at least possible.”