Dell Discount to Tech LBOs Is Shot at Success: Real M&ADavid Carey and Cristina Alesci
Michael Dell and Silver Lake Management LLC are wagering that their $24.4 billion plan to take Dell Inc. private will succeed where other big leveraged buyouts of technology companies have failed.
From 2005 to 2007, the peak of the buyout boom, private-equity firms completed four technology deals of comparable scale to the Dell deal yesterday, according to data compiled by Bloomberg. Two of the LBOs are mired in losses, while the others, including the Silver Lake-led acquisition of SunGard Data Systems Inc., have produced minimal gains for the buyers and their investors.
Dell, chairman and chief executive officer of the computer maker he founded in 1984, has negotiated a lower price relative to cash flow and a lighter debt load than the buyers in the earlier megadeals. While that doesn’t guarantee that the 47-year-old billionaire can turn his company around in the fast-changing computer market, it gives him the financial flexibility the other LBOs lacked and a shot at a higher return.
“This is a very reasonably priced deal,” said Scott Sperling, co-president of Boston private-equity firm Thomas H. Lee Partners LP.
Michael Dell and Silver Lake together will inject about $5.8 billion of equity into the deal, people familiar with the matter said. Dell will have a controlling stake in the private company.
Microsoft Corp., whose software powers many of Dell’s computers, will provide a $2 billion loan, according to a statement announcing the deal. The balance will be funded with $13 billion in additional borrowing and cash from Dell’s balance sheet, said the people, who asked not to be identified because the information is private. The deal’s enterprise value -- or market capitalization and debt minus cash -- is about $22.2 billion.
The enterprise value works out to about 5.1 times a measure of cash flow known as earnings before interest, taxes, depreciation and amortization, or Ebitda. The peak-era technology LBOs were priced at 9 times Ebitda or more.
“Tech buyouts valued at 7 times or less have often done well,” Sperling said.
The buyout will add $8 billion to Dell’s debt, bringing the total to $17 billion, the people said. Based on prevailing LBO loan rates and those on Dell’s existing bonds, annual servicing costs could be as much as $1.2 billion, or about 28 percent of Ebitda. That would leave Dell with $2.6 billion in cash flow after capital expenses and interest, based on the company’s financial performance in the 12 months ended Nov. 2.
The deal’s valuation compares with an average multiple of 9.2 times Ebitda for all LBOs announced or completed in the past 12 months, according to data compiled by Bloomberg.
Michael Dell and Silver Lake aim to replicate the outcome of a much smaller deal they did: a $2 billion buyout of disk-drive maker Seagate Technologies Inc. in 2000. It was the biggest LBO of a technology company at the time. Silver Lake, in which Michael Dell was an investor, led a group that scored more than 700 percent gain on the deal, according to a recent Silver Lake private placement memorandum obtained by Bloomberg News.
Silver Lake paid 2.6 times Ebitda, according to a regulatory filing. Flush with free cash flow, Seagate boosted research and development spending to $800 million in fiscal 2001, from $660 million the year before, and to $700 million in fiscal 2002. The step-up was pivotal to Seagate’s being first to market with the most advanced disks of the day.
“They invested and stayed on top of the product cycle, and they emerged a winner,” said John Moore, a Standard & Poor’s credit analyst in New York.
Even paying a favorable price, Michael Dell faces significant obstacles in trying to make good on his ambitions to break into new businesses such as cloud computing and mobile devices and lessen the company’s reliance on its weakening flagship PC business.
About 70 percent of Dell’s business is still tied to personal computers, which are “under secular and structural pressure,” even after it has spent $13 billion on acquisitions since 2008, Shaw Wu, a San Francisco-based analyst at Sterne Agee & Leech Inc., wrote in a Jan. 22 report. As much as half the company’s revenue is from desktop and notebook computers, and an additional 20 percent from businesses tied to such computers, he wrote.
While the reliance on the personal computer business has weighed on Dell’s growth prospects, it still helped the company produce an estimated average of $4.4 billion in Ebitda annually over the past five years. The megadeals done during the boom era were financed so aggressively that they were left without a capital cushion when the financial crisis hit, said Jamie Rizzo, an analyst at credit-rating company Fitch Ratings in New York.
“The projections going into these deals were close to perfection,” Rizzo said. “Then you get hit by a substantial downturn like we had and that no one was expecting, and it sets you back multiple years.”
A fast-evolving industry full of money-hungry startups, technology long was a magnet for venture capital that buyout sponsors shied from. Debt was seen posing too much risk in a field where cash flows can be volatile. Prior to 2005, the biggest technology LBOs had been valued at about $2 billion.
That changed when a Silver Lake-led group agreed to buy SunGard, a supplier of software to financial institutions and data-backup services, for $10.6 billion in March 2005. At the time, it was the largest LBO since KKR & Co.’s iconic acquisition of RJR Nabisco for $31.3 billion in 1989. SunGard shouldered $7.4 billion of debt and an interest-to-Ebitda ratio of almost 60 percent.
The SunGard deal was topped by the $11.1 billion purchase of NXP Semiconductor NV by KKR four other firms, including Silver Lake, in August 2006. NXP’s interest ratio rose to 55 percent.
A month later Blackstone Group LP and two other private-equity firms agreed to buy Freescale Semiconductor Inc. for $17.6 billion, leaving interest-to-Ebitda at 45 percent.
The largest technology LBO is KKR’s takeover of First Data Corp. for $29.7 billion in April 2007, about three months before credit markets started to collapse under the weight of subprime-mortgage defaults. The credit-card payment processor’s debt rose to almost $22 billion, with interest surpassing 70 percent of Ebitda.
The deals’ values ranged from 9.3 times trailing 12-month Ebitda for SunGard to 10 for Freescale, 12 for First Data and almost 15 for NXP, regulatory filings show.
Tailored to the companies’ cash flows, the debt wasn’t crippling at first. Then the recession hit, sales fell and debt service consumed an increasing portion of cash flows. Shifts in technology and customer tastes also took a toll.
NXP lost market share in key products, and Freescale’s results took a turn for the worse when sales of Motorola’s once-popular Razor cell phones tumbled and Freescale’s second-biggest business, selling chips to automakers, went into a free fall.
Several of SunGard’s biggest customers switched to newer and cheaper technologies, while a shift to debit-card card purchases and consolidation among financial-services companies cost First Data revenue. Since 2009, the four companies’ results have improved, although the effects of paying steep prices and using high leveraging linger.
NXP, which went public in 2010, has given investors, who sank about $4.5 billion into the company, an unrealized profit of about 10 percent after six years, based on the company’s recent stock price. SunGard’s backers, who in December extracted a $718 million dividend that returned about 20 percent of their money, are barely breaking even, said a person with knowledge of the matter.
With Freescale, whose IPO was in 2011, Blackstone and its co-investors have registered about a 60 percent loss on their $7.2 billion outlay, based on the current share price of $14.56 a share. KKR and other First Data shareholders have posted a 30 percent mark-to-market loss on their $6.3 billion investment, KKR’s third-quarter earnings statement shows.
Unlike Seagate, where the buyout helped the company solidify its position in a market where it was already strong, Michael Dell has made no secret of his company’s need to revamp its entire business. While a cash cushion will help, it may not be enough.
Dell faces an uphill battle as it seeks to challenge established rivals like Oracle Corp., EMC Corp. and Hewlett-Packard Co. in lines like servers and tablet computers, where Dell has little presence, Rizzo said.
“People are concerned about the business model,” said Louis Meyer, a special situations analyst in New York for broker Oscar Gruss & Son Inc. “You have a consumer business that is sort of dying on the vine. They may have products in development that could arrest that. But even if they do, they’ve still got to invest in that.”
Should he succeed, the reward for Michael Dell and his co-investors could be significant.
“This has the potential to make Michael Dell a lot richer than he already is,” said Erik Gordon, a private-equity and law professor at the University of Michigan.