Dell Shareholders Should Sit Tight

 | Feb 08, 2013 | 1:30 PM EST  | Comments
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We recommended Dell (DELL) a number of times last year. Our initial entry point was a money-losing proposition, but our subsequent updates and buy recommendations ranged from being profitable to very profitable.

Since the agreed-upon deal to take the company private is at $13.65 per share, and since the stock trades at $13.53, the next question is what to do now.

For reasons that we outline below, we recommend staying with the position for the time being. We believe that Michael Dell and Silver Lake will ultimately agree to add a sweetener and will pay a modestly higher price to address shareholder pushback on the very low valuation of the buyout price.

Having said that, if you have a compelling use for the Dell proceeds, we are OK with taking profits now, as we believe the additional upside is fairly limited.

Some quick thoughts on what happens from here:

We believe the deal will ultimately get done. (The company is targeting July of this year as a closing date, and we believe that is reasonable.)

We believe that the deal will be a very successful investment for Silver Lake and for Michael Dell, as we feel that Dell is not broken and will be able to revitalize the business as a private company and one day be monetized at a much richer valuation.

The deal is occurring at a very modest price. The buyout group is paying 8.3x 2013 earnings, 6.2x 2013 earnings, adjusted for cash, and 3.5x enterprise value to EBITDA.

When Michael Dell originally approached the board about taking the company private in August 2012, the stock was trading in the range of $11 to $12.25. So while $13.65 is a nice premium to its low of December 2012, it's not a large premium to where the stock was when Michael started the process. It seems logical that when he broached the subject last August, he probably thought he would have to pay more.

We do not expect anything positive to come from the 45-day "go shop" provision, and we do not expect a competing bid. Outside of a strategic buyer (which doesn't exist), Michael Dell is best situated to lead the group that is buying the firm.  Without Michael's involvement and contribution of his stock and additional funds, the leveraged buyout becomes a much riskier and more expensive proposition.

Having said that, we do believe that there will be significant shareholder pushback (from the likes of Southeastern Asset Management and Pzena Investment Management), along with class-action lawsuits challenging the price. The likely result will be a small sweetener that will get the final buyout price to the $14 to $14.50 level. (Interestingly, David Faber of CNBC challenged that thinking the other day, saying he didn't believe the buyout group would either have to or would raise its price unless shareholders vote the deal down, something we don't expect to occur.) So some smart people disagree with us on the potential sweetener.

The company will be paying its $0.08-a-share dividend per quarter until the deal closes. (If the deal closes in July, that would be an additional $0.16 per share.)

In sum, we believe it makes sense in the near term to let the situation play out and see if the buyout group is pushed to pay a higher price. If that occurs, that should provide holders with a reasonable low-risk return from here. Again, if you have a compelling use of the funds or if you don't believe there will be a higher price paid, you should start reducing your position.  

In the absence of a sweetened bid, the annualized return from current levels to July is about 4.2%, including expected dividend payments, which is OK compared to cash but might not look too compelling compared with possible market alternatives.

If the deal is sweetened by $0.50, your annualized return to the closing would be 11.5%, which is substantially more attractive. So ultimately, a large part of your decision to stay put should depend on whether you believe, as we do, that a sweetener is likely.

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