Endgame Arrives for Dell’s Buy Out Bid: As Usual the Arbs Hold the Cards

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Michael Dell looks in a strong position especially if he can sweeten the pot one last time….

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Michael Dell / Getty

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/ By Clive Minchom / 

Carl Icahn’s Letter to the Board

On July 1st the contents of an open letter from financier and corporate raider Carl Icahn to the shareholders of Dell Inc. (Dell), and to the special committee of its board overseeing its current efforts to go private, were revealed to the public. In that letter Icahn confirmed that he had now put in place over US$5 billion of credit lines to help to pay for his previously disclosed plan to recapitalize Dell as an alternative to Michael Dell’s own plan to privatize the whole company.
Essentially, Icahn has so far proposed to buy up 72 percent of Dell’s existing shares at US$14 per share, a price higher than the US$13.65 per share Dell founder and CEO Michael Dell and his partner, private equity firm Silver Lake Partners, have offered to pay for the company, though in their case to all shareholders, in a bid they first announced on February 5th, 2013.

Icahn, in his letter, asked the board committee to “engage in a direct, face to face sit down meeting with us” and argued that the board should consider his offer a superior one that would void a US$270 million breakup fee that Silver Lake could collect under certain conditions if its US$24.4 billion offer should fail. The Dell special committee of the board which thus far has not seemed too impressed by Icahn’s labours this time responded immediately, as indeed they must, with a very short reply:

“The Special Committee has reviewed Mr. Icahn’s open letter and will be pleased to review any additional information, including financing commitments, that it may receive from him regarding his recapitalization proposal. The Committee remains committed to achieving the best outcome for all Dell shareholders.”

Hardly a ringing endorsement, as Dell has thus far spurned Carl Icahn at every step and has indeed so far supported the Michael Dell bid as no superior alternatives have come along in the five months since they received it. But their reply is an effective stop-gap for the Special Committee to buy a little time to now try and invite Michael Dell and Silverlake themselves to increase their offer one last time, to push it over the top.

Background to What is Going On

Shareholders of Dell are presently finally due to vote on July 18th on Michael Dell’s offer. He is of course the founder, and presently also still a 16% shareholder, of the company and he is offering to buy out all public shareholders still at US$13.65per share in cash. He first made the bid in February in partnership with giant private equity firm Silver Lake as his partner. His argument for making the bid, though nowhere quite explicitly stated as there can be obvious conflicts of interest for an insider in talking at all, whereas a bid is allowed to speak for itself, is that the PC industry has changed and Dell must change with it, but that this can better be done in a private than public environment. An example would be perhaps if deliberate sales reductions are necessary to rebuild the company for the new PC environment – which could certainly be harder to explain in the public eye.

The background to both transactions now proposed is the strong evidence that the whole PC industry has shown signs of contracting, and moreover doing so structurally not just cyclically, for the first time in decades. This shrinkage has not been mitigated at all either, probably for the first time, by the release of a major new Windows release – Windows 8 – by Microsoft. Tablets are also making big inroads into the industry, it seems, with that particular charge being led by Apple and the Android crowd.

Michael Dell first made his offer several months ago which then put the company “in play”. Other potential bidders came and went without making a bid, and so it looked for a while then as though his might be the only game in town until financier and corporate raider Carl Icahn finally turned up to spoil the party with an intervention of his own. Instead of a complete buy out, however, he proposed only a partial buy-out of his own, and one using US$7.5 billion of the company’s own money to boot, plus a credit line he would arrange to top it up, leaving some shareholders remaining with him and in effect having accomplished a leveraged buyout of their own – but with Icahn in charge and the company saying “sayonara” to Michael Dell.

Icahn’s tactic with this letter is presumably either to just push the price up for an eventuallly successful Michael Dell bid at a higher price, which would reward him for having pushed the bid price up, from its present US$13.65, to who knows quite yet where it may end up. Or, he would find himself a winner having picked up the company for cheap with its own money and pushed out the founder, a person who is certainly not universally admired for what has already happened to Dell and its business performance in recent years. It is a very long time indeed since Michael Dell famously once said that Apple had no future and the best thing it could do would be to liquidate the company and give the money back to its shareholders…. the biter bitten maybe, or so it already might seem today…

Bring on the Arbs

Dell shares have apparently barely moved in response to Carl Icahn’s letter though, which is a key indicator that suggests that most shareholders – which here most importantly means those arbitrageurs, known affectionately in the business as “Arbs”, probably don’t think he is going to win. The shares this morning in pre-market trading at US$13.25. The shares have more or less remained pretty much stuck since February, when the company announced its plan to go private, trading no lower than US$13.09 and no higher than US$14.51.

In the rarified world of M&A, Arbs are the guys who take big bets on the outcome of an offer by buying up shares that institutions release to the market, while an offer is in process, in order take a large piece of the profit without having to wait to see a deal go all the way. Arbs are very influential to the outcome of a transaction, they also like to play to win and are professional investors who judge the odds of a deal closing when a company is put in play, and then accumulate shares simply in order to be the king-makers at the end of the process. The more a transaction looks soundly-based and likely to go the distance, as Michael Dell’s bid certainly seemed at the start, then by taking blocking positions with their own money they hope a competitor comes along so they can offer their blocs to the eventual winner – and it, or the original bidder himself, is gently encouraged to put up some more money along the way. Everyone knows who the Arbs are on Wall Street, or in capital markets in other parts of the world for that matter as it is a universal function that helps “lubricate” major transactions. It stands for “Arbitrageurs” which simply means taking a slice of a buy/sell deal on the way through, in this case of an M&A deal, hoping to guess correctly that it will proceed to an eventual closing above their buy-in price. Deals that founder and don’t close, can cost the Arbs a lot of money when a target company share price drops afterwards, which they don’t like at all. And everybody tries to be nice to them if they can, too, as who knows when they will be on the other side of one of their own deals?

By now it is very likely indeed that a large number Dell shares, maybe even up to a third – not already in the hands of Michael Dell or of Silver Lake or of Carl Icahn are now owned by such Arbs, who are just holding them betting that the buyout-offer will approved, or maybe even improved, and will yield them a guaranteed payout against the average price they recently bought in at. At the moment these shareholders are in the end probably going to vote for Michael Dell’s buyout, as the Icahn proposal could leave them stuck with a portion of their position afterwards, which would be messy, so they are probably now just hoping to just try to push up the price Michael Dell has to pay, one last time. So far this time around the offer price so far hasn’t gone up since the process started as no full-bid major competitive bidders showed up – in itself an indication that it has been a tough deal.

Deal By Newspaper

We read therefore just this morning in fact, the New York Times reporting that the special committee of Dell’s directors indeed have encouraged Michael Dell over the weekend to raise the offer price above its existing $13.65 a share, “a person briefed on the matter said on Tuesday”. So Mr. Dell may have to dig a little deeper into his own pockets if he wants his $24.4 billion bid for the computer company he founded to succeed.

The New York Times report goes on to assert that the special committee is also growing worried that the buyout offer may fail to win a majority of Dell shares, excluding Mr. Dell’s 16 percent stake at the vote on July 18, “the person briefed on the matter said”. Some 43 percent of the total of Dell shares excluding his own bloc need to vote in favour of the offer for it to win (i.e. just over half of the remaining total after subtracting his personal holding). It seems, again according to the report, “the directors have already taken a number of meetings with major investors that have left them pessimistic about the bid’s prospects, and now believe that a major shareholder advisory firm may even be poised to recommend a rejection of the takeover”.

Mr. Dell’s offer, made in partnership with Silver Lake, has been criticized for months by a number of big outside investors. But any bump in price would most likely come from the company founder, even though he has already made some concessions to reach the current price. Silver Lake Partners itself, which had refused to raise the bid beyond $13.60 at one point before the bid was made initially, has apparently itself become increasingly worried about the deterioration of Dell’s business, “a person close to the firm said. At the moment, it would not be devastated if the deal fell apart” – again according to the New York Times.

That has left Mr. Dell, who originally agreed to contribute his own 16 percent stake in the company to the deal at a discounted price of US$13.36 in order to leave more money for other shareholders as the only likely source of additional money. Yet while Mr. Dell listened to the suggestion, “he did not commit to a course of action”. Furthermore, Mr. Dell and his private equity partner in the deal, Silver Lake, have not had any discussions about raising the current price, “according to a person close to the firm”.

This is quite terrific stuff – let’s call it negotiation through the newspapers. Indeed successful PR is the key to most really effective M&A deals in a competitive public environment, as key information can be very quickly, and also ambiguously, communicated to large and important groups this way. At Sotheby’s art auctions, in contrast, it is much easier as everyone is there in the same room at the same time!

Closing-out the Deal

Finally there may be another wrinkle in all this, pointed out this morning by the tech-blog AllthingsDigital. If the Michael Dell – Silver Lake proposal fails to obtain approval at the Dell meeting of shareholders on July 18th, in order to fully get control of the company Carl Icahn would still have to convince shareholders to fire Dell’s board of directors as well, and then replace them with the slate he and his institutional shareholder ally Southeastern earlier proposed on May 13th. However, Michael Dell is still Dell’s single largest shareholder. And while he can’t vote one way or the other on the buyout proposal, he will certainly be able to vote against Icahn’s slate in a subsequent vote- and likely would have other shareholders with him then as well.

So call it what you will, a “high stakes game of chicken” perhaps, for Michael Dell, or maybe “Russian Roulette” is more appropriate… by July 18th we should know the outcome of this battle for sure. At this point I would put my money on Michael Dell in the absence of compelling competing alternatives.