Dell tells shareholders that it extracted a higher price from Silver Lake... and also that it's got big problems.
FORTUNE — Dell Inc. DELL today filed a proxy statement, detailing the process leading up its its $24.4 billion buyout proposal from CEO Michael Dell and private equity firm Silver Lake Partners. The proxy also includes details from the company’s recent “go-shop” period, which resulted in nonbinding indications of interest from The Blackstone Group BX and Carl Icahn.
The entire package is 274 pages long, and certainly would make a good Friday night read if you’re an M&A junkie (or, more specifically, a lonely M&A junkie). For the rest of you, here is a breakdown of the more interesting cuts:
Inception: The first group to approach Michael Dell about a possible buyout was Southeastern Asset Management, the company’s largest outside shareholder which has said it plans to vote against the current proposal. That was last June. The following month, a representative of Silver Lake approached Michael Dell at an industry conference to suggest the two sit down. The proxy does not say which industry conference, but I’m 99.9% certain it was Fortune Brainstorm Tech in Aspen (where Michael Dell and Silver Lake’s Egon Durban both spoke). Michael Dell soon would reach out to another private equity firm (believed to be KKR) for advice, before formally advising Dell’s lead independent director, Alex Mandl, on August 14. Three days later the entire board was informed and began putting M&A infrastructure in place — including the creation of a special committee.
Financial mismanagement: The driving force behind the special committee seemed to be less that Michael Dell wanted to buy Dell, and more that Dell management was serially incapable of accurately forecasting company performance. For example, on August 21 the company reported quarterly earnings that were around $300 million less than internal management projections. Overall, Dell’s revenue came in significantly below management projections for seven straight quarters and, save for one quarter, below consensus analyst estimates. Things got so bad that, at one point, the special committee asked Boston Consulting Group — which already was advising on strategic alternatives — to provide independent financial analysis of the company’s prospects.
To be honest, it’s kind of a wonder that CFO Brian Gladden still has his job. Moreover, if Blackstone Group were to launch a hostile bid, this financial information could be its most effective defense (i.e., current management — including Michael Dell — is unfit to run the business). Of course, that would assume Blackstone would be willing to risk its reputation on such an offer, and that it has the financial resources to replace the equity Michael Dell is rolling over as part of the Silver Lake deal (not to mention Microsoft’s $2 billion loan). Oh, and that it has another CEO in place. Again, the chances of a formal Blackstone bid keep getting smaller the more I think about them.
This section also must be the toughest for Dell to swallow as a company, since it may make fidgety customers and employees even more nervous. On the other hand, Hewlett-Packard HPQ may be having a good laugh at its Austin rival’s expense.
Pricing: Silver Lake originally proposed a purchase price range of $11.22-$12.16 per share, assuming that Michael Dell would roll his shares into the deal. Kohlberg Kravis Roberts & Co. GS also put in a bid for $12-$13 per share, assuming Michael’s shares plus those held by Southeastern — plus a $500 million additional investment from Michael. Important to note that Southeastern was unaware of the KKR offer, and thus was ignorant of its hypothetical role.
The special committee, however, felt both offers undervalued Dell. Then, on Dec. 3, a Goldman Sachs GS analyst suggested that the company might be ripe for a leveraged buyout — sending Dell stock up 4.4% to $10.06 per share. The next day, KKR dropped out of the process. It told special committee advisor J.P. Morgan JPM that its main sticking point was the uncertain PC market and competitive pressures — two factors validated by Dell’s recent performance. That same day, Silver Lake raised its offer to $12.70 per share.
As the special committee kept pressing for a higher price, Michael Dell kept making his case for going private. He identified four things he would do with a privately-held Dell: (i) Increase R&D for the company’s enterprise services group, (ii) Hire additional salespeople, (iii) Expand in emerging markets, and (iv) Invest new money into the PC and tablet business. In other words, he wants to create growth rather than strip-and-flip.
Then came a Bloomberg news report that Dell was in buyout talks, sending the stock up to $12.29 per share. The next day Silver Lake upped its offer to $12.90, but it was still seemed insufficient. Alex Mandl began talking to Michael Dell about strategic options were Dell to remain public, much of which involved cost-cutting (which was the opposite of Michael’s stated vision). Mandl also told Silver Lake that $13.75 was the magic price, but Silver Lake just couldn’t get there and threatened to walk. After a few more proposals it got to $13.65 per share, with Michael rolling over his shares at $13.36. This proposal also would allow Dell to continue paying out its dividend — something it offered to suspend if the offer hit $13.80.
In short, the special committee moved Silver Lake from $11.22-$12.16 to $13.65.
Southeastern math: When the agreement was announced, Southeastern issued a statement saying that $13.65 per share “grossly undervalues” Dell. It also offered up its own analysis, saying the company is worth at least $24 per share. In private, however, Southeastern said it would be okay with a $14-$15 per share bid so long as it and other “large existing” shareholders were given the opportunity to roll over a portion of shares. Later in the proxy, the “large existing” language is dropped in favor of the more inclusive “shareholders.”
Go-Shop: Evercore Partners contacted 67 different parties during the go-shop, with 10 entering the process. We’ve already detailed the end results, but a few interesting tidbits (1) Insight Venture Partners, working with Blackstone, has never held discussions with members of Dell management. (2) As Fortune previously reported, Blackstone threatened to walk away unless Dell agreed to reimburse its out-of-pocket expenses. (3) TPG Capital conducted two weeks of due diligence during the original process, opting not to submit a bid. But it did reappear during the “go-shop,” working with Blackstone. Unclear why it wasn’t part of the final Blackstone bid, but that sure makes it harder for Blackstone to do this deal without Michael Dell’s shares. (4) Still unclear why the special committee thinks Carl Icahn’s proposal could result in a superior bid, when it is premised on a dividend recap that the special committee already examined and determined would pose too many long-term risks.
Strip sale talks: During negotiations with Silver Lake, Dell received a call from an undisclosed strategic party, expressing interest in purchasing Dell Financial Services at book value ($3.5b-$4b). Boston Consulting Group examined the proposal, but determined it would not create sufficient value for Dell. Worth noting that another strategic party — believed to be General Electric GE — signed a joiner to Blackstone’s non-disclosure agreement, in order to conduct due diligence on DFS. This suggests Blackstone would sell DFS to GE — a likely point of contention with Michael Dell (yet another reason why Blackstone is unlikely to bid).
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