Dell Technologies (DVMT) – Expected Sweetened Offer – 10%+ Upside

Current Price – $92

Expected Price – $105+

Upside – 10%+

Expiration Date – Dec 2018 (or Q1 2019)

Offer Filling and Presentation

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).

For more detailed quick take take on the situation please refer to articles in Barron’s and Bloomberg. Further insights can be found on VIC, PSAM Presentation and Icahn’s letter.

 

DVMT pre-background

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

Current Offer:

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!

19 COMMENTS

  1. work 22

    What do you think about being long DVMT and short VMW? (though I know there is potential for a big dividend paid from VMW to help pay for the DVMT deal, so you’d have to get out of the way before then)

    1. work 22

      Part of the reason i bring up the idea of long DVMT/short VMW is to hedge one self as the market/macro situation seems ugly (as of mid-late October 2018)

      1. makarid

        I completly agree with your view. If you short VMW and go long DVMT, if the VMW announces the dividend and the price appreciates, will the DVMT appreciate also,because is a tracking stock? So if this is true, we can cover the short after the announcement and we will not have a huge lost. In the meantime we are protected from a market selloff.

    2. Alex15

      I personally play this situation unhedged, because of the dividend you mentioned and because it would add an other component to an already complex situation.

  2. Nicholas Wiswell

    Well, we’ve hit the original target price already, but there’s still a big gap to VMW shares. What’s the play?

  3. Michael Lax

    I am tempted to play this with a long call spread, but am not sure how to calculate the potential 41% of consideration which may be paid in C shares, given there is no current public market for C shares, any thoughts?

    1. dt

      I do not think anyone can answer this question. If market is pricing this situation efficiently, then with DVMT at $106, new Dell should trade at c. $50/share (as compared to $80/share that management used to build their case).

      But this $50/share is still far from the clean price estimate:
      - How much of further potential bump in price is already included in $106? Meaning that if shareholders approve current deal then DVMT price might drop after the announcement.
      - How is market pricing the risks of deal breaking altogether if shareholders oppose current transaction?

  4. dt

    I am tempted to wait for Icahn’s response. If he objects the transaction, I would expect another small jump in the stock price. But even with Icahn objecting I am guessing that shareholders will approve current proposal during the meeting.

    1. Alex15

      I am exiting my position but might get back into the situation if the price drops a bit. I agree that the chances are now high and we definitely won’t see a higher bit.

    1. dt

      The special situation part played out already. It might be that at the current price new Dell is undervalued, but that is another story.

      I expect most of DVMT shareholders to tender for cash option and then after the tender price will drop significantly.

      What kind of play besides potential new Dell undervaluation do you see in here?

  5. Jim Rivest

    dt, I have until Dec 19th to tender, so I’m holding off tendering. It’s very possible DVMT can increase in price over the next 18 trading days and that hurts us in the stock exchange (i.e., we receive considerably less value). So I may just sell DVMT vs. tendering it if that is the case. Everybody has to make their own assessment of DELL’s value.

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