When interest rates drop, you and I might consider buying a slightly larger house. Michael Dell considers buying large chunks of the tech ecosystem.
Dell Inc. and its platform of all-star owners — founder Michael Dell, MSD Capital (Dell’s investment arm), and pre-eminent private equity group Silver Lake Partners — today announced they have signed a definitive agreement to acquire EMC in a deal valued at approximately $67 billion. The deal will get done with a mixture of Dell equity, additional cash, a tracking stock that will be issued for EMC subsidiary VMware, and debt. Dell and Silver Lake will put at least an addition $3.5 billion in equity into the deal.
This deal reflects the massive amount of leverage deal-makers can gain in today’s free-and-easy debt markets. Keep in mind that when Dell went private a couple of years ago, it was valued at less than $30 billion. It’s acquiring a much larger company.
In strategic terms, the deal is broad and looks very smart: Dell gains storage-and-hardware specialist EMC and virtualization giant VMware in a clean move. Dell officials say in the press release that they see it as a market-share play for “extremely attractive high-growth areas of the $2 trillion information technology market.”
But it’s even more fun to look at how this deal even happened, through the magic of financial engineering. There are enough financial mechanics in play to confuse even the most adept Harvard Business School (HBS) candidate. Let me try to explain through my own, non-HBS-educated eyes.
EMC holders would receive $24.05 per share in cash in addition to shares of a tracking stock linked to Dell’s slice of the VMware business. VMware has a market value of about $33 billion. Dell says EMC shareholders would receive about 0.111 shares of new tracking stock for each EMC share.
EMC was valued at a little more than $50 billion last week, and shares have risen about 30 percent since news reports of the pending deal were reported by The Wall Street Journal. But it still hasn’t closed the gap on the deal offer, which is $33.15 per share. (Today, EMC was trading at about $28 per share.) VMware shares have sunk about 6 percent this year — and fell sharply today, down 10 percent in morning trading.
Clearly, the market still expresses some skepticism about the financing of the deal, given that EMC shares are still trading $4 short of the deal price and VMware shares are falling.
Some other things the market action tell us about the deal:
1) For years, EMC has been perceived as undervalued, especially for its stake in VMware (it owns about 80 percent of VMware). For example, prior to the deal, EMC stock was trading at a price/earnings ratio of less than 10 times earnings. The value of the stock today still excludes the bulk of VMware’s $33 billion market capitalization. This drew technology hedge fund Elliott Management in to pressure for a solution to “unlock value.”
2) Elliott, which owns about 2 percent of EMC and regularly harasses technology giants including Juniper Networks, approves of this deal. Elliott is going to make a lot of money and has demonstrated it thinks it has found a mechanism to “unlock the value,” in part by breaking out VMware as a tracking stock to help finance the merger. So, will we see more M&A like this? Maybe not as big — but expect Elliott to stay active.
3) Because the VMware tracking stock is listed as a financing mechanism for the deal, this appears to be the “unlocking” of EMC’s stake in VMware that the market has been looking for. However, the market is not reflecting the deal at full value: Does not mean the tracking stock is somewhat discounted?
In the end, let’s think of this deal as a virtual spin-off of VMware. VMware gets its tracking stock, but it’s not really independent. Yes, the value of the world’s most powerful virtualization player has become virtualized by the stock and debt markets.