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Dell LBO Could Require $20 Billion In Financing

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Dell LBO Could Require $20 Billion In Financing

Dell Inc. (NASDAQ:DELL)’s stock is once again reacting to media speculation that the company could be in buyout talks with private equity firms. While there are reasons for Michael Dell to work with PE investors to take the company private, the risks of executing on its transition strategy could go up in such a scenario unless the PE investors are open to continue injecting capital to support the company’s strategic goals. Additionally, the deal size could be an impediment in executing a transaction of this nature.

Fundamentals of PC Market

According to a new report from Gartner,  Shipments at DELL were less favorable than the overall market, falling 21% y/y and flat q/q. These results indicate Dell Inc. (NASDAQ:DELL)’s PC-centric revenues came in slightly below initial estimates for the Jan-qtr of +2.5% q/q(-21% y/y)as intense competition from Hewlett-Packard Company (NYSE:HPQ) and Lenovo impacted results. The company’s market share did improve by 170bps q/q to 12.2%, however, despite the possibility that Dell Inc. (NASDAQ:DELL) attempted to protect margins vs. gaining market share.

Media speculation indicates potential for an LBO

A Bloomberg article during the day indicated that Dell is potentially in buyout talks with private equity firms. Dell is not new to such speculations due to its historical stock performance, large holding by Michael Dell (16% of shares outstanding) and high free cash flow yield. In the past, management has denied any such plans while there have been some statements attributed to Michael Dell indicating that he has considered taking the firm private.

Lots of reasons for private-equity investors to get involved

Dell’s high free cash flow yield combined with cheaper financing options do make it easier for the math to work in its favor in a leveraged transaction. Additionally, management could work on its transition strategy without the pressure of meeting quarterly targets. Investors could cut the less profitable portions of Dell’s business (consumer and low-end PCs, and third party software), reduce costs and make the organization more focused and leaner before going public again.

BUT… the deal size and strategic reasons could make the transition even harder

Dell is in the middle of expanding its focus on more profitable parts of the business, which could need significant investments as well
as enhanced capability to make more acquisitions.

Analysts at Mizuho Securities belive that unless the private equity investors are willing to continue injecting capital to support strategic decisions, the company’s transition to be more enterprise focused could become even harder.

Shaw Wu, an analyst at mostly agrees with the assessment  He notes  that this is possible but the likelihood is low as it would take sizable financing for a company of Dell’s size with its $21 billion market cap. In addition, a deal of this size would likely involve multiple PE firms. Furthermore, Wu estimates that the majority of its businesses (70%) remain under structural and secular pressure.

BMO analysts have a slightly different view of the possible LBO.

They believe that Dell’s single biggest challenge is to change the nature of its income statement – to dilute, or lower, the contribution from client revenues (desktop and notebook PCs). They think the PC market will experience ongoing unit and revenue pressure. Furthermore,  Dell still generates about 48% of revenues from clients.

Therefore, BMO believes that Dell will want to continue to buy non-client IP, such as software. If Dell does go private, it will add material leverage to its balance sheet, which they think will limit Dell’s ability to buy assets and diversify its revenue stream.

BMO calculates that if Dell were to go private at $17/share, and Michael Dell were to roll his equity into the deal, then Dell would need to raise about $20 billion in financing. If one further assumes this financing is all debt, then the total debt would be about 6.3x BMO’s projected FCF in FY2014. Hence, from a strategic level, while BMO thinks that Dell’s balance sheet and FCF could support an LBO, they believe that it is reasonable to assume that Dell will want to maintain financial flexibility to buy more assets, and not go private.

Disclosure: No Position

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