Monday, July 2, 2018

Dell Technologies: Dell Class C Reverse Merger via DVMT

Today we received the answer to the question of how much of a discount Dell was going to force down on the DVMT tracker? Turns out, quite a bit!  While I'm disappointed in the result as the discount is essentially unchanged from the day after the Dell EMC deal closed, the current price bakes in a significant discount for the Class C shares and you might see activists push for an even better deal.

Dell bought EMC in the fall of 2016, EMC owned 80% of VMWare (VMW) and Dell issued a tracking stock (DVMT) for much of that 80% VMWare ownership position that in spirit was meant to be economically equivalent to one share of VMW.  Turns out that was a lie!  Maybe lie is too strong of a word, Dell always had several options available to it in the DVMT documents to provide less than VMW value to DVMT share holders, but its certainly against the intention of the tracker and the EMC board should be a little embarrassed, with today's new, Dell essentially engineered a way to pay a lot less for EMC/VMW.

Here are the terms of the deal, as of Monday afternoon, DVMT is trading for ~$91.50, a 16% discount to the headline $109 number and a full 43% discount to VMW's current price of ~$160.  Even at the full $109 number, DVMT shareholders are accepting a 31% discount to VMW:

Dell Technologies is a private company, the main goal of the DVMT conversion is to do a reverse pseudo-merger with the tracking stock to bring Dell Class C public again without going through the costly traditional IPO process.  The headline number is $109 for DVMT with an election between cash or Dell C Shares, although if you pick cash you'll likely be significantly pro-rated (cash is capped at 41% of the total).  Coinciding with this transaction, VMWare is going to pay a special dividend to its shareholders (including Dell Technologies which owns 81% of VMW) and then Dell is going to turn around and use the $9B they receive from VMW to finance the cash consideration portion of the transaction with DVMT.  Smart, Dell is using VMW's own cash to buy DVMT at a 31% discount to VMW, an immediate gain to Dell Technologies' equity value.

Valuing the Class C shares get a little tricky.  Dell has a significant amount of debt and owns stakes in three publicly trade subsidiaries (VMWare, Pivotal, Secureworks).  Dell provides a slide using the $109 headline number:
If you recreate this slide and plug in $91.50 at the top, the implied equity valuation of Dell ex-public subsidiaries drops from $17.5B to $750MM.  Core Dell has about $32B of net debt (not including their financing subsidiary or debt at VMW) and did $6.9B in EBITDA over the last 12 months, with the $750MM implied market cap today, the market is placing a 4.75x EBITDA multiple on the old Dell/EMC businesses, seems quite punitive to me.  Or even more ridiculous (maybe just meaningless) but at a $750MM market cap, Dell's P/E off of their "adjusted net income" ex-public subsidiaries number would be less than 1x.

Now there could be good reasons for the discount.  Class C shares have essentially no voting rights, so while the tracking stock discount will be removed when the new shares are issued, the "Michael Dell minority shareholder" discount will still be present.  Similarly, but does the old tracking discount just move over to being a HoldCo discount at Dell Class C?  About half the enterprise value and the majority of the equity value at Dell is its stake in VMWare, will it trade at a big discount like we see other HoldCo's trade at today?  That's the more likely answer, the whole enterprise is being discount, not just the legacy business.

Reading the press release, you can see that management is spinning the conversation away from the DVMT/VMW discount and referencing the headline premium to Friday's close.  In fact, if you flip through the presentation, its almost like DVMT wasn't intended to ever track VMW, no mention of "track" or "tracking" anywhere, just a pre-IPO roadshow deck .  Elliott Management and Carl Icahn both own DVMT, Dell's press release states that Dell consulted with owners of 40% of DVMT and "received feedback", doesn't say that those giving their feedback agree with the consideration DVMT shareholders are receiving, so I wouldn't be surprised if one or two put up a stink about accepting such a large discount.  DVMT shareholders will get to vote on a deal in October, maybe this transaction goes through as is but something just feels a bit wrong accepting such a wide discount two years after the tracker was issued.

I'm continuing to hold as the market seems to be overly discounting the new Dell shares and under estimating the potential for some additional shareholder pressure to sweeten the deal.

Disclosure: I own shares of and call options on DVMT