Dell Slashed Equity Portion of EMC Deal During Negotiations

  • Buyout group originally planned to raise $16 billion of equity
  • Equity cut in final days when banks agreed to offer more debt

Michael Dell’s buyout group originally planned to raise far more equity for its $67 billion acquisition of EMC Corp., then slashed the figure during negotiations as banks agreed to fund almost three quarters of the purchase price with debt.

In the lead up to the largest technology deal ever Michael Dell and financing partner Silver Lake Management estimated they would raise as much as $16 billion by issuing preferred and common stock, according to a regulatory filing dated Feb. 12. By the time the deal was announced on Oct. 12 -- and just months before one of the biggest credit-market selloffs in years -- the combined equity contribution by the Dell and Silver Lake group had been winnowed down to $4.25 billion.

The buyers were able to minimize the amount of capital deployed -- and so boost their potential returns -- because banks including JPMorgan Chase & Co. committed to raising almost $50 billion of debt financing. The same might not be so easy now: In the months since the Dell-EMC deal was announced, bond markets have become much more volatile, making it more difficult to complete highly leveraged transactions.

“In this risk-off environment, we would like to see more equity, not less,” said Kingman Penniman, the chief investment officer of KDP Asset Management Inc., a Montpelier, Vermont-based money manager that specializes in high-yield bonds and leveraged loans. “It’s a lot of debt and the markets are sort of looking at it to see how it is going to be accepted.”

James Hahn, a Dell spokesman, declined to comment.

More Equity

The change in financing conditions has been noted by several private equity managers, including Josh Harris, co-founder of Apollo Global Management LLC, who said in late January that funding markets are “shutting down.” Several weeks later, David Rubenstein, the co-chief executive officer of Carlyle Group LP, told investors and analysts on a Feb. 10 conference call that buyout firms may have to start contributing more equity to get deals done.

Credit rating organizations have generally blessed the EMC deal, in which Dell Inc., the Round Rock, Texas-based PC maker founded by Michael Dell, will pay $24.05 a share in cash along with tracking stock tied to EMC’s stake in VMware Inc. That’s because the acquisition of EMC, which makes storage devices, will lessen Dell’s dependence on the flagging PC market and allow the combined company to generate more than enough free cash to cover the additional debt, said Jason Pompeii, a senior director at Fitch Ratings Ltd.

“Dell is already on the march to becoming an investment-grade company,” Pompeii said in a telephone interview. The cash flow from the combined companies “is substantial enough to pull forward the time frame,” in which Dell can reach investment grade status, he added.

Bank Debt

To finance the transaction, Dell and its affiliates will take on about $20.5 billion in bank debt, according to the February filing with the U.S. Securities and Exchange Commission, with another $25 billion raised through the sale of secured and unsecured high-yield bonds. The buyers have also arranged to borrow about $2.5 billion through a margin loan secured by part of EMC’s stake in VMware, and another $1.5 billion secured by promissory notes that VMware had previously issued to EMC, the filing shows.

That wasn’t always the plan, according to the filing. In mid July, Dell’s representatives told EMC that financing for the deal would include $14 billion to $16 billion in new common and preferred equity. That figure was refined in a Sept. 1 letter to EMC’s board that stated the buyers would raise $6 billion to $11 billion of preferred equity from “unspecified existing limited partners,” of Silver Lake and $3 billion to $8 billion of new equity from Michael Dell, his family office and Silver Lake and its co-investors.

Revised Structure

In a Sept. 23 letter, Dell presented a revised structure that included $7 billion of preferred equity and as much as $4 billion of common, the filing says. On Oct. 2, a draft merger agreement was circulated that included provisions for the purchase of preferred and common stock, as well as a debt-commitment letter from the banks that included a funding condition tied to the preferred shares.

During the next 10 days of negotiations, the two sides discussed “deal certainty risks associated with Denali’s ability to secure its proposed preferred equity financing,” according to the filing. The two sides ultimately agreed that the financing would consist of only $4.25 billion in common equity, with the remainder provided through debt and VMware tracking stock.

The early estimates reflected the amount of equity that Dell thought would be needed to complete the EMC buyout, according to a person familiar with the situation who requested anonymity because the details of the negotiations were confidential. The buyout group ended up being able to finance a larger proportion of the transaction with debt at a time of historically low interest rates, a second person familiar with the situation said. That represented the best cost of capital.

To help make up the difference, Dell agreed to give EMC shareholders tracking stock equaling 65 percent of EMC’s VMware stake, up from an earlier promise of 60 percent. That represented a $1.2 billion increase in value at the time the deal was announced.

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