Therese Poletti's Tech Tales: Carl Icahn is right about Dell’s complex, self-enriching attempt to re-enter public market

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Carl Icahn has successfully tormented several tech companies in the last decade — from Motorola to Yahoo to eBay — but usually demands value extraction that isn’t always the best route for a company’s health or long-term investors.

Icahn’s new battle with computer executive Michael Dell and his eponymous company, now entering a bruising second round five years after the first, is different: It is a righteous stand that other large investors appear to be backing.

The activist investor is opposing Dell’s convoluted deal to go public with an argument that makes sense. Simply put, Icahn and other investors in the so-called Dell tracking stock DVMT, +0.99% — issued as part of its mega acquisition of EMC Corp. — believe Dell’s stated offer is far too low. Icahn goes even further to state that Dell’s plan “significantly benefits Michael Dell and Silver Lake, but at a huge cost to the DVMT stockholders.”

Icahn’s argument is similar to his opposition of the management-led buyout which took the computer maker private in 2013: The proposed deal will mostly enrich Michael Dell and his private equity partner, Silver Lake, to the detriment of other investors. Icahn also dug into a copy of “The Prince” and said Dell & Co. are engaging in scare tactics “reminiscent of the tactics Machiavelli advised the Borgia rulers to use centuries ago.”

“It is clear to me that Dell and Silver Lake have followed Machiavelli’s advice to the letter: It is better to be respected than loved, but better still to be feared than respected,” Icahn said in a regulatory filing last week. He will vote against Dell’s unorthodox proposal to go public again, in its current form.

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Other large investors, as well as a major advisory service and some analysts, seem to agree. Two weeks ago, P. Schoenfeld Asset Management, a firm advising clients with more than $150 million in stock at stake, sent Dell’s board a letter opposing the plan. Fund managers at PSAM and two other large investors, Black Rock Inc. and Elliott Management did not respond to requests for comment, though BlackRock is reportedly opposed to the deal and Elliott was considering rejecting it.

The debate about the value of the Dell tracking stock began in July when Dell announced its complex plan to return to the public markets with a proposed offer of $109 in cash for each share of the Dell tracker, or exchange each share for 1.3655 shares of the newly public Dell. Icahn Enterprises has amassed 8.3% of the Dell tracker stock, which was based on EMC’s controlling stake in VMware Inc. VMW, +4.04% and was key to raising funding for the $60 billion EMC deal.

Investors believe that the offer undervalues VMware and its cloud and virtualization software business. Icahn said he estimates the $109 is really more like $94 a share, based on a variety of factors, and that he believes it is really worth $144 a share. PSAM said in its letter to Dell that the offer was too wide a discount and that “at least a 20% improvement to the consideration would narrow the discount to 17% or lower and would be fair to both sides.”

Institutional Shareholder Services wrote a brief report earlier this month on the situation, stating that for tracker shareholders, “fair value likely falls somewhere between what they were sold” — at the time of the EMC merger, when executives called it the “best tracker ever” — and what they now hold, a tracker that trades at a 37% discount [as of Oct. 5] to the underlying stock,” counterbalanced by the structural protections built into that tracking stock.

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Dell said in its public filing it has held meetings with various investors of its tracker stock, known as Class V shares. “In those meetings a number of Class V stockholders expressed concerns regarding the economic terms of the Class V transaction,” Dell said. “The board of directors and the Special Committee continue to believe that the Class V transaction is in the best interests of the Class V stockholders.” Dell added that even though it is committed to the transaction as proposed, in late September it began to “re-evaluate an initial public offering of the Class C Common Stock as a potential contingency plan in the event that the Class V transaction is not consummated.”

A spokesman for Dell said its offer represents a 29% premium to the tracking stock’s value prior to its July announcement and the company continues to believe that the offer “is fair and in the best interests of DVMT shareholders.” He also noted that an independent special committee representing the holders of the tracking stock has had discussions with about 40% of its shareholders and had arms-length negotiations with Dell.

It determined, “consistent with its legal obligations, that this transaction was the best available option for DVMT shareholders,” the Dell spokesman said.

Last Friday, Dell said it scheduled its special shareholder meeting for Dec. 11 to vote on its proposed offering. In Dell’s updated proxy materials, the company urges investors to disregard any proxy cards sent to them by anyone other than Dell Technologies. Dell also recently reiterated its previous statement, that it would consider a traditional IPO for its Class C shares alone, if the current offer fails.

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Icahn believes that Dell’s talk of an IPO of its standard Class C shares is a fear campaign to get investors to vote instead for the tracking stock deal.

“We believe that a Dell IPO would face significant challenges and trade very poorly given the possibility of the issuance of a tsunami of stock in connection with a forced conversion,” Icahn said. PSAM agrees that an IPO of Dell Technologies without a “negotiated outcome” for the tracker stock holders “is not a viable path.”

It’s true that an IPO of Dell Technologies Class C shares on their own would be unlikely to excite investors. The company, which reported its fiscal second-quarter earnings in September, is still losing money, even with 18% GAAP revenue growth in the quarter. Investors may also balk at the massive debt on its balance sheet, much of it associated with the EMC deal. In September, Dell said it had total gross debt of $50.1 billion remaining, since paying down $13.7 billion since it has closed the EMC deal.

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In addition, investors buying Class C shares alone would be buying shares in a controlled company, where they don’t have any real voting power, with Michael Dell and Silver Lake Partners owning at least 65.1% of the company’s outstanding common stock.

Dan Ives, a Wedbush Securities analyst, said in a note Monday that the only way he believes a deal gets done is via a “higher cash component and an overall sweetened bid, (e.g. warrants, etc).”

“A combined valuation in the $130-$140 range through a range of these options for the DVMT tracker would get this deal consummated,” he wrote.

So far, Dell appears unwilling to give in, but Icahn still has nearly two months to get investors to see his point of view. In the first round of this fight, Icahn threw in the towel against Dell’s buyout efforts when it became clear that he did not have the support to replace the board, but along the way Michael Dell and Silver Lake did slightly up their offer. History may repeat itself if Dell really wants to get this deal done.

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