FORTUNE — Dell Inc. this afternoon reported lower-than-expected earnings, including a stunning 9% year-over-year revenue decrease and 65% operating income decrease for the “end user computing” unit that houses PC and PC peripheral sales.
Silver Lake Partners obviously knew that the EUC business was in decline when it agreed to join forces with Michael Dell on a $24.5 billion buyout offer for the company (DELL) — believing that it could more than make up for future PC-related losses by growing other parts of the business. But it’s also fair to suggest that some at Silver Lake may be getting nervous by how quickly things have deteriorated (including in mobility, which seems a bit counterintuitive).
So if Silver Lake did want to walk away, could it?
In general, private equity firms have only two ways out of a signed merger agreement. First, they can simply agree to pay a predetermined termination fee — but it’s usually set so high that no firm would consider taking the hit. In the case of Dell, Silver Lake and Michael Dell would be on the hook for a whopping $750 million.
The second option would be to claim a material adverse change in the business. If successfully claimed, then Silver Lake would be off the hook.
On the surface, a decrease in Dell’s primary business would seem to qualify. It’s certainly “material” by Dell’s own admission, since it was reported in its quarterly financials. And it’s certainly an “adverse change,” based on almost any reasonable definition of that phrase.
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The reality, however, is that it is extraordinarily difficult for private equity firms to successfully make MAC claims. The most notable example came when Apollo Global Management (AGM) tried to bail on its agreement to have portfolio company Hexion Specialty Chemicals buy Huntsman Corp. (AGM) for approximately $10.6 billion. The original deal was signed in July 2007, but the subsequent financial markets collapse and other factors caused Huntsman to experience several subsequent quarters of poor performance. Moreover, Huntsman’s net debt had unexpectedly increased and two business units — pigments and textiles — had been hit particularly hard.
A lawsuit was filed, and the two sides squared off in Delaware Chancery Court nearly one year after the original deal was signed. The judge ultimately sided with Huntsman, arguing that the changes to Huntsman’s business was more to specific units than to the company as a whole and that plaintiffs had not proved that the overall business wouldn’t recover. Hexion ultimately agreed to settle for approximately $1 billion (banks that backed out of the deal also paid through the nose).
Since then, many MAC agreements have gotten more stringent. Some, for example, include “bright-line tests” that specify the acquirer can bail if certain financial results fall beneath a particular threshold.
In the case of Dell, however, the MAC is fairly amorphous. Silver Lake is allowed to walk away if any change since Nov. 2, 2012 would “have a material adverse effect on the financial condition, business, properties, assets, liabilities or results of operations of the Company and its Subsidiaries taken as a whole.” But then there are a whole bunch of carve-outs, including broader industry trends (unless Dell is more negatively impacted than its peers) and the company failing to meet either internal or external financial projections.
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Silver Lake certainly could argue that the “end-user computing” decline, while just one business unit, adversely affects the entire company since it represents more than 60% of of Dell’s total revenue (something that wasn’t true of Huntsman’s pigments and textiles groups). Moreover, it’s an accelerated secular decline that is not really expected to ever reverse itself.
Hardly a slam-dunk case, but Silver Lake would seem to at least have a line of argument.
So let’s imagine that Silver Lake were to claim MAC, so long as it could handle the potential reputational fallout for a firm that hangs its hat on knowing technology trends inside and out.
In that case, Dell still may go private. Remember, Silver Lake only has committed $1.4 billion toward the deal. Michael Dell has that kind of extra cash lying around — and maybe could even float the $2 billion Microsoft (MSFT) loan if the Redmond crew were to follow Silver Lake out the door (since Microsoft is exclusive to the existing consortium, which would be blown apart). Moreover, he might be able to negotiate a lower price, since it would be obvious no one else is walking through the door (well, maybe except for Carl Icahn).
Again, a TON of hypotheticals here. Silver Lake may very well move forward with its offer, and take Dell private before the July 4 holiday. But given today’s earnings mess, it’s worth at least considering the alternatives.
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