Dell’s Growth Slump Shows Urgency of Silver Lake Buyout
Dell Inc. (DELL)’s board is predicting another year of lackluster growth in fiscal 2014 as demand for personal computers ebbs, underscoring the urgency behind the company’s decision to be taken private, documents show.
Sales for the year ending in January will slip to $56.5 billion, and Dell’s PC business will shrink by $10 billion over four years, according to projections in a proxy statement filed yesterday with regulators. Operating income will be stagnant at $3 billion, according to the documents, which shed light on a $24.4 billion buyout proposal led by Silver Lake Management LLC, as well as plans by Chief Executive Officer Michael Dell to accelerate a turnaround after going private.
The documents outline a worsening outlook for Round Rock, Texas-based Dell that set the stage for negotiations -- kicked off in June by shareholder Southeastern Asset Management Inc. -- that included company executives, a special committee of the board, Silver Lake and their respective financial and legal advisers. Dell is considering the resulting $13.65-a-share bid alongside competing offers from Blackstone Group LP (BX) and billionaire Carl Icahn that it says could prove superior.
CEO Dell told his board that going private would be the best course of action because it would let him boost spending on acquisitions, sales staff and research and development, while investing in PCs and tablets and expanding Dell’s reach in emerging countries, according to the filing with the U.S. Securities and Exchange Commission.
Undertaking those investments while trading on public markets would be “poorly received” by investors since they would “weaken earnings and cause greater volatility” in the stock price, Dell told the board during a presentation in December.
The documents also lend insight into the sometimes contentious negotiations between Dell’s representatives and private-equity firm Silver Lake, which came close to walking away from the deal in January, as well as a stalemate that wasn’t resolved until Silver Lake upped its final offer by 5 cents a share at the eleventh hour -- ultimately boosting the bid 22 percent from $11.22 at the outset.
CEO Dell sought to take his company private as slumping demand for computers and accelerating competition eroded sales and hammered the stock. Dell, who founded the company in a college dorm room in 1984, is betting that he can enact a turnaround more swiftly outside the glare of the public markets. Dell and Silver Lake may need to sweeten their offer as Blackstone and Icahn work to line up the financing required by their respective proposals, which were submitted during a so- called go-shop period that ended just after midnight March 23.
Blackstone’s plan values Dell at more than $14.25 a share, while Icahn would pay $15 a share in cash for as much as 58.1 percent of the stock, Dell said March 25. Under both plans, some shares may continue to be publicly traded.
Dell met with Blackstone this week to discuss the company’s proposal, people with knowledge of the matter have said. The executive deems Blackstone’s offer management-friendly, one of the people has said. Blackstone is open to keeping Dell on as CEO, another person said.
Hewlett-Packard Co. and Lenovo Group Ltd. also scanned Dell’s books during the go-shop period, people with knowledge of the matter have said.
The idea of an LBO was first suggested by Southeastern, Dell’s largest outside shareholder, on June 15, according to the filing. Southeastern proposed participating in a deal by rolling some of its shares into the company. CEO Dell said he would consider it. Southeastern now opposes the Silver Lake deal, saying it undervalues Dell.
On July 17, Michael Dell met a representative of Silver Lake at the Fortune Brainstorm technology conference in Aspen, Colorado, and they arranged to meet again in August.
In mid-August Dell told Alex Mandl, the company’s lead independent director, that he was interested in possibly taking the company private and asked for information to study the feasibility of a leveraged buyout. The board was open to the idea. In late August, the company reported revenue of $14.5 billion, about $800 million less than the board had forecast in June and $300 million below a revised outlook.
By the end of the month, the board had retained law firm Debevoise & Plimpton LLP and JPMorgan Chase & Co. as its advisers, and by early September, the company had entered into confidentiality agreements with Dell, Silver Lake and a second private equity firm identified only as “Sponsor A.” That firm is KKR & Co., according to a person with knowledge of the matter.
The month following the earnings disappointment, the company revised its outlook due to shrinking customer demand and margins, changes in the PC market and greater competition.
On Oct. 23, when Dell’s share price closed at $9.35, Silver Lake and KKR submitted preliminary, non-binding proposals to acquire the company. Silver Lake bid $11.22-$12.16 a share for all stock excluding that of Michael Dell, whose collaboration was a condition of the offer. Sponsor A bid $12-$13 for all shares except Dell’s and Southeastern’s, and suggested an additional $500 million investment on Michael Dell’s part.
On Nov. 15, Dell reported quarterly earnings that missed analysts’ expectations and its own guidance again, causing its shares to fall about 7.3 percent to a three-year low of $8.86. By then, it had hired Goldman Sachs Group Inc. and Boston Consulting Group Inc. as advisers.
Boston’s research would later underscore the decline in Dell’s business. The division that includes PCs would decline by as much as $10 billion in four years, Boston predicted. Acquisitions “had yielded far lower returns” than management had expected, the firm said.
Also in November, Silver Lake and Sponsor A submitted revised bids, and on Nov. 30, Dell expressed his enthusiasm for an LBO to the board, saying he could “supply as much additional equity as might be needed for a transaction.”
On Dec. 3, Goldman Sachs analysts wrote a report suggesting that Dell might be the target of an LBO, sending the company’s shares up 4.4 percent to $10.06. That same day, Sponsor A withdrew from the process, later citing the uncertain market for personal computers and competitive pressures on Dell for its decision.
The following day, Silver Lake submitted a revised bid of $12.70 per share.
On Dec. 6, Michael Dell told the board he thought that his plans to invest in research, development and M&A, as well as expanding the company’s sales staff and emerging markets operations, would be better undertaken as a private company than as a listed one.
“Mr. Dell reiterated his belief that implementing such initiatives would require additional investments that could weaken earnings and cause greater volatility in the performance of the common stock,” according to the filing.
On Dec. 10, the board told Silver Lake any bid would have to be significantly higher. At that point, Silver Lake said it would need to seek financing from Microsoft Corp. (MSFT) That month, private-equity firm TPG Capital -- identified in the proxy only as Sponsor B -- also signed a confidentiality agreement with Dell, a person with knowledge of the matter said.
On Jan. 16, two days after Bloomberg News first reported that Dell was in buyout talks, Silver Lake submitted a bid of $12.90 per share, backed by commitments from Barclays Plc, Bank of America Corp., Royal Bank of Canada and Credit Suisse Group AG, as well as $2 billion from Microsoft.
The board balked at the price, and said it would support a bid of $13.75 per share. Silver Lake responded that it could offer no more than $13.25, though it raised that to $13.50 later in January. Dell lowered the valuation of his rollover shares to $13.36 so that Silver Lake could raise its bid to $13.60.
On January 24, Dell advisers received calls from Blackstone, Southeastern and a so-called Strategic Party A expressing interest in all or part of the company. The unidentified party is General Electric Co., which sought Dell’s financial services division, a person with knowledge of the matter said.
Silver Lake raised its bid to $13.65 per share on Feb. 4. After meeting throughout the day, Dell’s board finalized the merger agreement, which included a go-shop period, and announced its plans the next morning.
During the go-shop process, Evercore Partners Inc. contacted 67 parties, including 19 potential strategic bidders, 18 financial sponsors and 30 others, including sovereign wealth funds. Four others expressed interest unsolicited. Altogether, 11 parties were open to a transaction, but only three -- Icahn, Blackstone and Strategic Party A -- submitted proposals by the end of the go-shop process on March 23. Two days later, the board said in a press release that it would continue to support the merger agreement with Silver Lake while continuing negotiations with Blackstone and Icahn.
Michael Dell’s employment agreement with the Silver Lake group entails a stock-option grant with an aggregate exercise price of $150 million. The company didn’t give an estimate of the value of those options, which have a 10-year term. The company estimated last year that a 2011 10-year option grant to Dell was worth about one-third of the options’ exercise price. Applying that ratio to the Silver Lake award would value it at about $50 million.
Michael Dell has agreed to forfeit the options he currently owns in the company. The Silver Lake group may strike employment agreements with the company’s other top executives and let them invest in the new company, according to the filing.
Blackstone is proposing a leveraged recapitalization transaction whereby investors could choose to get either all cash or equity, subject to a cap, if they want to stay invested in Dell. The shares would continue to be publicly traded.
The private equity firm, which has teamed with San Francisco-based buyout shop Francisco Partners and New York- based venture firm Insight Venture Partners, said it plans to fund the transaction with a combination of equity and debt, in addition to Dell’s cash and equivalents. Blackstone said it held discussions with some of Dell’s largest shareholders and plans to invite them to join the transaction.
Icahn is offering shareholders the option to roll over their stakes or receive $15 a share in cash, with the amount of cash limited to $15.65 billion, according to the statement. Icahn has enlisted Jefferies LLC to conduct due diligence.
Icahn’s offer assumes that Southeastern and T. Rowe Price Group Inc., the largest Dell investors after Michael Dell, would contribute their stakes and won’t receive a cash payment.
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