The deal is a complicated financing structure that will spread the debt Dell is trying to raise over a number of markets.
Dell’s $67 billion acquisition of EMC will not only be one of the largest tech deals ever, it could also be one of the most leveraged. But that doesn’t seem to have stopped the banks from wanting in.
According to Dell’s proxy statement, eight banks have committed to providing the company with as much as $49 billion in financing. One question was how the banks would structure the deal given that regulators and the market are increasingly worried about rising risks in the corporate lending market. One banker tied to the deal said there was a concern that regulators would flag the deal because it had too much leverage. What’s more, the high-yield loan market has slowed recently, with investors particularly worried about buying debt tied to merger transactions.
The result is a complicated financing structure that will spread the debt Dell is trying to raise over a number of markets. According to one banker close to the deal, Dell will raise a total of $45 billion in debt to do the deal, slightly lower than has so far been reported. Only about $10 billion of that though will be bank loans. On top of that, the banks will provide an additional $3 billion in a revolver. Dell is expected to raise about $10 billion through the high-yield market. Institutional shareholders have committed to providing $8 billion in funding to the deal. But the big surprise is that bankers are expecting to be able to sell $17 billion in high-grade bonds connected to the deal.
Just how leveraged the deal is is hard to tell. The combined Dell-EMC EMC is expected to have $56 billion in debt after closing. EMC is expected to generate $6.3 billion in EBITDA (earnings before interest, taxes, depreciation and amortization). Dell hasn’t released earnings numbers since it went private in 2013, but back then its EBITDA was $4.5 billion. And there is some indication that Dell’s cash flow has slipped since then. Still, use those numbers and the deal has a leverage ratio (Debt-to-EBITDA) of around five times.
Regulators have warned banks against lending to deals with over six times leverage. So Dell-EMC appears to be below that bar.
The average leveraged buyout deal this year had a leverage ratio of 5.7. So Dell-EMC is not high for all deals. But for large tech deals, which tend to have less debt, the leverage in the deal is very high. For instance, Carly Fiorina’s much maligned acquisition of Compaq when she was head of Hewlett-Packard only resulted in a combined leverage ratio of 2.3. The most recent large tech deal to even come close is Broadcom’s $36.5 billion takeover of Avago Technologies, which was announced earlier this year. And even in that deal the leverage ratio was only 3.2.
What’s more, the Dell-EMC deal comes at a time when investors are increasingly worried about corporate debt. Corporate bond spreads, or the difference between how much companies have to pay in interest to borrow and U.S. Treasuries, have been rising. There have been more downgrades of corporate bonds this year than at any point since the financial crisis. And coverage ratios, or how much more companies are making than the debt they owe, have been falling. And there is some sign that debt investors are worried about the Dell-EMC deal. Existing bonds tied to EMC have sold off since the link-up has been announced.
Nonetheless, the Dell-EMC deal shows that if there is a growing bubble in the corporate debt market, at least for now, the banks don’t see it.