A company once valued at $18bn on the US stock market will come full circle on Tuesday when shareholders in a little-known listed entity called DVMT vote on whether to accept a reverse merger offer from Dell. If they say yes — and most observers expect them to — the computer company born in Michael Dell’s dormitory room almost 40 years ago will return to the stock market after a five-year hiatus with a hotly disputed enterprise value of as much as $100bn.
Away from the glare of Wall Street, Mr Dell — who had become frustrated with the mutual funds and retail investors who dismissed his efforts to reinvent the company — celebrated the solitude of the private market, saying the company had “the freedom to invest in a future that lies beyond the next quarter”. The deal was secured with the help of Silver Lake Partners, a prominent Silicon Valley-based private equity firm.
The business logic for relisting is clear. What was once a fading PC business has been transformed into a diversified technology group going head-to-head with the likes of IBM, Microsoft, Hewlett-Packard and Cisco.
But Dell’s route back to the public market has proved controversial, triggering an M&A brawl that pulled in activist investors including Carl Icahn, raised questions over private company valuations and led to accusations from some shareholders that Mr Dell and Silver Lake were playing hardball in the brutal talks around the DVMT deal to squeeze every cent they could get for themselves.
A spokesman for Mr Dell and Silver Lake said that they would not comment for this story in advance of Tuesday’s shareholder vote.
Mr Dell and Silver Lake invested roughly $10bn in Dell, starting in 2013. Their combined stake of about 75 per cent is now worth more than $25bn. But some DVMT shareholders — including Mr Icahn, who has led opposition to the reverse merger, activist hedge fund Elliott Management, and the massive index investor BlackRock — successfully argued for improved terms for all shareholders. “Although they [Mr Dell and Silver Lake] got their pound of flesh,” says Mr Icahn, “if we hadn’t been there, it would have been three [pounds].”
The reverse merger leaves perhaps $10bn of extra value accruing to Mr Dell and Silver Lake from the public shareholders of DVMT. For some, the half-decade saga has confirmed that savvy private equity firms enjoy an advantage over public market investors.
US stock markets have experienced a sharp decline in IPO listings. While over the same period private equity firms such as Silver Lake have raised tens of billions of dollars to target entrepreneurs who have preferred to build shareholder value outside public markets before going to the market to crystallise their gains.
The question has become how public investors can grab a part of that pie.
“Private equity can buy up companies, fix operations and make them more nimble,” says Jill Fisch, a professor of corporate law at the University of Pennsylvania. “But for the public investors on the other side of leveraged buyouts, there is the risk of buyouts being opportunistically timed.”
The seeds for the Dell management buyout were planted in Hawaii. Mr Dell’s vacation home is not far from that of Egon Durban, a brash dealmaker who joined Silver Lake at its launch in 1999. The buyout firm had made a name for itself after lucrative bets on companies such as Alibaba and Skype.
Mr Dell, who owned nearly a fifth of the company, spent $14bn on several software acquisitions in the years leading up to 2013 in an effort to turn Dell into a one-stop shop for corporate IT departments. Unfortunately, shareholders were unimpressed, sending Dell’s shares down by nearly a third between 2010 and 2012.
By 2013, Mr Dell and Mr Durban struck a deal to take the company private at a price of $13.88 a share, a premium of more than 40 per cent. But shareholders were wary. Management buyouts, where chief executives have insights into the business that ordinary shareholders lack, are unpopular.
“MBOs should be removed from the corporate lexicon,” says Charles Elson, a governance expert at the University of Delaware. “The CEO is both a buyer and a seller in the transaction and is hopelessly conflicted.”
Investor unrest forced up the bid by a couple of per cent. Yet by the beginning of 2014, Dell was a private company and saddled with $18bn of debt — including $2bn borrowed from Microsoft.
In many ways Mr Dell and Silver Lake complemented one another. The founder was a tech fanatic with little interest in the intricacies of finance. With Silver Lake glued to the numbers, he could focus on strategy.
The buyout timing was also propitious. The Nasdaq index appreciated by nearly 20 per cent between the end of 2013 and the end of 2015. And though Dell did not have an official stock price, given its high leverage its private valuation would have been turbocharged.
Once private, it cut costs, tightened operations and offloaded divisions. But in 2015 Dell and Silver Lake had the chance for a game-changing acquisition.
EMC had become the dominant player in data storage. It had also become a hodgepodge of tech assets with units in software security and big data. However, its crown jewel was a subsidiary called VMware whose market value was $35bn. VMware had pioneered “virtualisation”, the innovation where software applications do not have to reside on individual machines.
In September 2015, Dell announced it would buy EMC for $67bn, the biggest technology acquisition in history. Suddenly Dell had a complete set of products to sell to IT departments.
To pay for the deal Mr Dell and Silver Lake borrowed nearly $50bn. The pair, along with Temasek, Singapore’s sovereign wealth fund, bought around $5bn in fresh equity in Dell* — paying $27.50 a share, twice the 2013 valuation. But to find the outstanding amount Dell had to be creative.
As it was private, the company could not issue stock to EMC’s public shareholders. But VMware, EMC’s prized asset, was public. So Mr Dell and Silver Lake offered EMC shareholders $24.05 a share in cash and a piece of a so-called “tracking stock” in VMware that was supposed to trade closely with VMware’s market price. Evercore, the investment bank, projected that the DVMT tracking stock would be likely to trade within 10 per cent of VMware’s valuation — making EMC shareholders happy to take it.
Joe Tucci, EMC chief executive, proclaimed: “This should be the highest quality tracker in the history of trackers . . . we would not have done this if we thought it was going to cost [investors] any economic pain whatsoever.”
For Silver Lake and Dell, the DVMT tracker would become both a windfall and an albatross. The discount to the standard VMware share ranged between 30 and 40 per cent rather than the 10 per cent that had been forecast between 2017 and the first half of 2018. The gap meant that of each dollar of value of VMware that EMC shareholders had sold to Dell, only 60 to 70 cents had accrued to them. One hedge fund that had supported the creation of DVMT would later denounce the structure as “highway robbery”.
The tracker’s investor base was largely comprised of hedge funds. And some wanted an opportunity to even the score with Mr Dell and Silver Lake.
By 2018, the extended bull market, particularly among tech stocks, made it a good time to take Dell public. Silver Lake would also at some stage need to harvest its gains and distribute them to its pension and endowment investors.
Dell had come to the conclusion that its best approach for going public was through a reverse merger where shareholders of the DVMT tracker would swap those shares for newly created stock in Dell that would then trade freely. A traditional IPO was ruled out because it could have taken more time and led to a lower valuation.
The talks with DVMT were handled by two of Dell’s independent directors, David Dorman and William Green, former chief executives at AT&T and Accenture respectively. By July, the pair and Dell announced a deal.
But the backlash against it from DVMT shareholders exposed the inherent flaws of the tracker structure. The merger valued DVMT at $109 a share. DVMT started trading at around $45 in 2016 and so long-term investors stood to make a handsome return. However, $109 was still a 25 per cent discount to the VMware share price DVMT was supposed to be tracking.
The larger problem for DVMT shareholders was that the $109 felt illusory, 60 per cent of it was to come in the form of stock in the relisted Dell.
Yet there was no widely accepted valuation of the private Dell. Mr Dorman, Mr Green and the company had settled on a per-share valuation of Dell at $79.77, meaning each DVMT share would be swapped for 1.4 Dell shares. In 2016, at the time of the EMC deal, the private Dell shares had been valued at $27.50 each. By late 2017 and early 2018, Dell shares were being valued at between $33 and $49 each.
After the merger terms were announced, DVMT never approached its $109 value. Dissident shareholders worried that Mr Dell and Silver Lake had priced their company to minimise the portion of Dell they would have to hand to DVMT shareholders.
“That deal was dead on arrival,” says one large DVMT shareholder. But one person familiar with the talks says critics misunderstood the negotiating dynamic. “Dell could have done an IPO and forced a DVMT conversion at a far lower premium,” the person says. “The reverse merger was the least worst option.”
Mr Dorman and Mr Green declined to comment for this story.
Securities filings reveal that Dell initially tried to merge with VMware as a route to go public, but that the talks broke down after its board dismissed Dell’s valuation of itself. Dell then moved on to the DVMT negotiation.
DVMT shareholders hated the maths of the July offer. But the steep market sell-off in the autumn created pressure for them to return to the negotiating table in October since a DVMT deal would ensure at least some profits for the year. A shareholder vote on the reverse merger was scheduled for December 11.
Behind the scenes Silver Lake and Mr Dell quietly assembled a group of DVMT shareholders — including Elliott, BlackRock and Dodge & Cox, a San Francisco-based asset manager — to hammer out a compromise. On November 14, Dell announced a revised DVMT reverse merger now worth $120 per DVMT share, up from $109 in July. Four key investors agreed to vote in favour of the recut deal. Several others told the FT this persuaded them to fall in line.
The shortcoming of the July deal became evident in the days after the revised November terms were announced. Based on where DVMT trades today, the implied value of Dell is just $47 a share, a far cry from the $79.77 the company and special committee had agreed to in July. Dell’s implied equity valuation — $36bn — based on current trading of DVMT shares suggests that virtually all of Dell’s value comes from its VMware stake and virtually none from its core business.
As for how the company is welcomed back to the market, memories of Mr Dell and Silver Lake’s bare-knuckle tactics may linger. One hedge fund manager warns: “This reputation for profoundly aggressive behaviour, all for a one-time money grab, will haunt them.”
However, a second investor offers a different interpretation. “The deal will finally align the economic incentives of DVMT shareholders with those of Michael Dell and Silver Lake,” says Josh Wool, an investor at Carlson Capital, which has a large stake in DVMT. “It will be refreshing to finally all be in the same boat, and rise and fall together.”
*The story has been corrected to note that $5bn was paid by the entire buyout group
Negotiations: how the two sides agreed to determine Dell’s value
The trickiest negotiation in corporate finance may involve valuing a private company. With no trading price, a buyer and seller may not even know where to start negotiating. One insight from Dell’s return to the public markets is that finding such common ground may not be so necessary.
When Dell first proposed a reverse merger with its listed affiliate, DVMT, the PC maker valued its private shares at $79.77 each. At the $109 a share July offer price for DVMT, each share swapped would receive nearly 1.4 shares of the newly listed Dell.
Virtually all DVMT shareholders rejected that $79.77 as too high. The revised deal, on which there is a vote on Tuesday, states that there is no official share price for the soon-to-debut Dell. Instead, the exchange ratio will be determined by how DVMT trades over the 17-day period between November 28 to December 21.
The headline value of this new deal is $120 per share. DVMT shares will be swapped with new Dell ones at an exchange ratio falling between 1.5 and 1.81. If, however, DVMT trades below $120 because of shareholder scepticism of the original $79.77 Dell valuation, shareholders will get closer to 1.81 shares to cover any shortfall.
The precise ratios and decimal points on this “top-up” mechanism were hotly contested over a few frantic days of spreadsheet diplomacy spearheaded by Elliott Management according to multiple people involved. But it proved to be a far more popular solution to the Dell valuation problem than the two sides themselves having to pick a single number.
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