Current Price – $92
Expected Price – $105+
Upside – 10%+
Expiration Date – Dec 2018 (or Q1 2019)
This idea was shared by Alex.
This is a large cap special situation that has been widely publicized and because of that is likely to be priced efficiently. I do not have any specific insights therefore the below is more of the heads-up-post rather than original idea.
In a nutshell, DVMT (at $92) was supposed to be almost 1 for 1 tracking stock of VMW (at $146). However, it currently trades at 35% discount due to corporate governance issues and investors expecting Michael Dell to screw them. And he is finally doing that by offering to take-under DVMT owners with cash and stock deal that supposedly values DVMT at $109, which is already a rip-off compared to VMW share price. On top of that, cash portion of the deal accounts for only 40% of the total and the remaining will be distributed in new Dell stock (at what investors call a lofty valuation). There have been a number of publications criticizing this deal as being unfair (linked below) and last week Carl Icahn started activist campaign (with 8% ownership) and encouraged shareholders to vote against the proposed transaction.
So the main investment angle here is that Dell will bow to investor pressure and sweeten the deal for DVMT holder either by increasing the cash portion or giving bigger proportion of the new Dell stock or both. Expectation of the bump range between 5%-20%. (the latest Barron’s headline indicates $120-$130 per share aspirations).
Dell Technologies (which went public in 1988 with a $30mm IPO) is a highly-leveraged hardware company facing great secular challenges. The company went private back in 2013 in a controversal $24.4bn deal. To build and diversify his tech empire Michael Dell purchased EMC Corporation, a better positioned hardware and software company, whose crown jewel was it‘s 82% ownership interest in VMware (or VMW). VMware is giving Dell Technologies relevance in the cloud computing era. Michael Dell lacked the finances and couldn’t purchase the entire stake which is why he needed to create the tracking stock. And thus DVMT was born with a promise of tracking the value of ownership in VMW
Under the terms of the transaction, shares of Dell’s Class V Common Stock (DVMT) will be converted into the right to receive a fixed number of shares of Dell Class C Common Stock at an exchange ratio of 1.3665 shares of Class C Common Stock for every share of Class V Common Stock. Based on an implied value of $109 per share of Class V, this would represent an equity value for Dell’s DHI group of $48.4 billion and total consideration to holders of Class V shares of $21.7 billion. Alternatively, holders of Class V shares can elect to receive $109 per share in cash in an aggregate amount not to exceed $9 billion. That is equivalent to a 41/59 cash-stock split. Following the completion of the transaction, the Class C Common Stock will be listed on the NYSE.
Merger is likely to get voted down
Carl Icahn (8,3% shareholder) gives a good conclusion in his open letter why he opposes the deal:
Dell sold EMC stockholders the Tracker assuming, at most, no more than a 10% discount, yet today, Dell and some of those same bankers are now soliciting your vote to agree to exchange your DVMT shares at a 36% discount! (DVMT share price $91.74 and VMware stock price of $141.49). Because a tracking stock is unusual and rarely included as merger consideration, Dell and its bankers had to convince EMC stockholders that the Tracker would efficiently “track” the economic value of VMware shares. To that end, one of Dell’s bankers at the time delivered a fairness opinion that assumed the Tracker would trade at a range of +/- 5% to VMware shares; while another banker assumed the Tracker would not trade at more than a 0-10% discount to VMware shares.
If the transaction is consummated the discount, regardless if you calculate with a merger consideration of $109 or with $94 (as Icahn does) is pure profit to Dell. Therefore, he has a strong motive to buy the tracker at a huge discount and overstate the value of the merger consideration by inflating inflate the valuation of the unlisted Dell Technology. There are plenty of reasons for the >30% discount, i.g. fear of forced conversion with Dell Technology and poor governance by a Dell influenced board. But as always with tracking stocks and NAV discount situations, it’s a bit difficult to be precise.
Michael Dell needs a majority of the holders of the tracking stock to approve the deal. Their “yes vote“ is unlikely in my opinion, because of the discount and the position that Dell technology is in. Therefore it is only logical that several other investors have expressed their unwillingness to vote in favor (here). An Oct. 18 record date has been set, by which time investors needed to hold the tracking stock to be eligible to vote. In addition, there are other customary closing conditions, which I assume as given.
Risk and negotiating leverage
To counter investor pressure Dell threatens to continue as a standalone company or proceed with an IPO (and subsequent forced DVMT conversion). However, because of high leverage (more than $48bn in debt) and rising interest rates these seem quite empty threats. However, if the merger is voted down without prospects of a sweetened offer, shares are likely to trade lower. Before the official announcement on 2nd of July the stock traded at ~$85. First rumors have come up in January where the stock was also trading in the $80 range.
In case the transaction is accepted on current terms, DVMT stock price will also decline – current price likely already reflects some probability of a sweetened deal.
Shareholder meeting is set for 1tth of Dec, so there is a chance situation will get resolved till then. However, DVMT holder rejection might be necessary before Dell bows to their demand with a subsequent sweetened offer. In any case this should get sorter out one way or another in Q4 2018 or Q1 2019.
Certainly happy to hear other opinions on this idea!