On Monday, Dell definitively announced that it plans to acquire IT giant EMC (EMC) for ~$67 billion, making it the largest “tech-only” deal in history. EMC shareholders will receive ~$33.15 total for each share of EMC owned, representing $24.05 in cash and 0.111 shares of brand new tracking stock of VMWare (VMW), of which EMC owns ~80% of the company. The transaction includes a “go-shop” provision that allows EMC to find a more desirable deal.
The value of the tracking stock, which in some ways represents a synthetic publicly-traded equity component of the deal structure for Dell (it could have paid all cash), could deviate from the market price of VMWare, given the different characteristics and rights of the stocks. Though several factors could allow this not to happen, we would expect a retirement of the tracking stock upon deal closing (expected in the months of May-October 2016) as the transaction price is finalized. The use of such an equity component helps Dell participate in a lower transaction price in the event shares of VMWare fall pre-closing, as they have been doing since the deal was announced.
There have been many instances of the use of tracking stock in the past, most notably during the dot-com bubble, and Dell’s participation in the transaction may bring back nostalgia for some. Sprint (S), AT&T (T), Genzyme, Applera Corp, WorldCom, Cablevision (CVC), and Sony (SNE) have used tracking stock in the past, mostly during the late 1990s. The SEC offers some “fast answers” on tracking stocks on its website, the link provided here. For simplistic reasons, we would have preferred Dell pay EMC shareholders in cash and Dell take ownership of the VMWare stake without creating tracking stock, an instrument many investors are not familiar with.
The agreement price represents a nearly 28% premium to EMC’s closing share price on October 7, just before the news broke that a deal was in the works. It also represents over a 37% premium to EMC’s closing share price on September 8, the day we highlighted EMC on our list of 5 US-Centric Undervalued Stocks with Fantastic Economics. Though investors should become familiar with the risks of tracking stock and the internal conflicts of interest that may arise under such a structure, we generally think EMC shareholders are getting a fair deal in the context of our independent valuation of the company, our fair value estimate, relative to the proposed buyout price.
The merger will significantly expand Dell’s operations; the firm went private in 2013 in part to mitigate the negative stigma related to a falling share price but also to speed up its transition from a personal computer based business to a more diverse company, which now looks to be attacking the data storing and managing businesses. Going private will also offer EMC a similar type of benefit, as it can now avoid the pressures of a weak share price, which had brought calls from major investors to break up the company. Those shareholders are probably pleased with the deal price, but aren’t exactly comfortable with the tracking stock dynamic either.
In addition to the weakened PC demand that has impacted Dell’s PC manufacturing operations, both Dell and EMC have had trouble competing with cloud services businesses that allow companies to efficiently outsource data managing and storage to cloud-based data centers, such as offerings from Amazon (AMZN), Google (GOOG), and Microsoft (MSFT). EMC’s data processing and storage businesses have also faced significant pressure from free, big data software programs that eliminate consumers’ need to purchase many of its software and hardware products.
As a result of the struggles of its businesses, EMC had reportedly begun a strategic review in 2014 to explore its options. The firm also announced an expense reduction plan in July 2015 in which it planned to cut $850 million in annual costs. Long-time CEO Joe Tucci was scheduled to retire in February 2015, but did not do so amid the company’s struggles. The merger will effectively end his search for a suitable replacement when it closes, which is expected to occur sometime between May and October 2016.
The deal will be financed through a combination of new common equity from Dell CEO and founder Michael Dell, as well as financial backers MSD Partners, Silver Lake, and Temasek, the issuance of tracking stock, new debt financing, and cash on hand. After the deal, Mr. Dell and the related stockholders will own approximately 70% of the combined company’s common equity, and the newly-formed entity will spend its first 18-24 months after the transaction rapidly delevering its balance sheet, a task that should be relatively easy for the combination of two robust cash-generating operations.
Dell has no immediate plans to return to being a publically-traded company, as the reduced concerns that are generated from public investors have given the firm flexibility to focus solely on its customers while investing for long-term results unabated. EMC’s operations will realize a similar, pressure-reducing benefit. The combined company will be the world’s largest privately-owned integrated technology company, and the complementary product portfolios will create a leader in servers, storage, virtualization, and PCs. The Dell-EMC transaction is a powerful one.