Dell’s Mitzvah Rescued Buyout as JPMorgan’s Lee Warned of Perils

When Ken Duberstein’s secretary told him Michael Dell was on the phone on the afternoon of July 31, there was little doubt about the topic. That morning, Dell Inc.’s special board committee had rejected the latest offer from Dell to take the personal-computer company private, a battle that was dragging into its 11th month.

“What do we need to do to get this deal over the goal line?” Dell’s founder and chief executive officer recalled asking.

Raise the bid, responded Duberstein, a 69-year-old tough-talking former chief of staff for Ronald Reagan who sat on the special committee.

Duberstein, now a Washington, D.C., lobbyist, laid out the stakes for the 48-year-old executive in another call later that evening. If the deal wasn’t approved -- a shareholder vote was scheduled for two days later -- Dell might lose control of the company he founded in his University of Texas dorm room in 1984. A no vote would indicate a lack of confidence in Dell, and some board members had already lost faith in his management, according to three people familiar with the directors’ thinking. If activist shareholders began calling for Dell’s ouster, the board might be inclined to honor the request, these people said. Dell declined to comment.

Fifteen minutes later, Duberstein’s home phone rang. “It’s a mitzvah,” said Dell, the Hebrew word for a good deed, or in this case, a deal that would be good for all. He and Egon Durban, his financial partner at Silver Lake Management LLC, which co-sponsored the LBO, had agreed to increase their offer by 13 cents a share. Shareholders would get $24.9 billion, or $13.88 a share, for a stock that was trading lower than $9 before Dell announced his bid. The board would escape criticism that it had folded before the iconic CEO. And Dell would get to keep his company -- and a shot at redemption.

Failed Deal

“Michael might have lost the board if the deal failed,” said Jimmy Lee, the longtime chief of investment banking at JPMorgan Chase & Co. who advised the special committee with Kurt Simon, head of technology, media and telecommunications. Lee had earlier warned Dell: “People you thought were with you will be against you.”

A representative of the board’s special committee declined to comment.

With the deal’s official closing yesterday, Dell will now embark on one of the most challenging buyouts in history as he tries to accelerate a four-year effort to turn the struggling Round Rock, Texas, PC maker into a supplier of all the hardware, software and services needed to run Internet data centers. With revenue of $57 billion, Dell is the largest company ever to be taken private based on sales, according to data compiled by Bloomberg. By size of the deal, the LBO is the 10th-biggest, data from market researcher Preqin show.

Revered Wunderkind

If he succeeds, Dell could complete one of the most unlikely personal makeovers in business history. A decade ago, he was gracing magazine covers, the revered wunderkind whose direct-sales model made Dell the best-performing stock of the roaring 1990s. Now, as the buyout unfolded over the past year, he had to overcome a frustrated board preparing to appoint a strong second-in-command over his objection, a bid by buyout firm Blackstone Group LP that may not have included him, and a potential proxy fight by billionaire investor Carl Icahn to install a new board that would have replaced him.

There were plenty of other obstacles. Dell’s board demanded six price increases before even agreeing to put the proposal to a shareholder vote. To try to drum up a better deal, the board then hired another bank that talked to 72 potential bidders during a lengthy “go-shop” period. Twice, the CEO had to accept a discount on his shares in the company to increase the offer while Silver Lake refused to budge, and once had to sit by as Durban got into a nose-to-nose screaming match with Jimmy Lee.

Unknown World

“This is a guy from Austin who founded his own technology company and now he is on Wall Street trying to buy it out and he is entering an unknown world,” Lee, 61, said.

“It’s like going into a haunted house,” he said, “and every time you go around a corner some ghost pops up, and then a witch flies down on a broom, and then you go into another room and some devil tries to stab you with a pitchfork.”

Lee, who has worked for JPMorgan or its predecessors since around 1975, helped negotiate Comcast Corp.’s acquisition of NBC from GE in 2009, the United-Continental airline merger in 2010 and General Motors Co.’s $23 billion IPO later that year.

The transaction was “more challenging than I thought,” Dell, who had read almost a dozen books on private equity as he embarked on the LBO, said in an interview. “But I am a believer that what doesn’t kill you makes you stronger.”

Tennis Match

He has no love lost for Icahn, from whom he received two congratulatory phone calls before and after the shareholder vote approving the deal on Sept. 12.

“It was like a tennis match where there’s all kind of trash-talking, and then afterwards you’re telling each other ‘nice backhand’ and ‘great serve,’” Dell said of his chat with Icahn. “For Carl, it was all just a game. But it’s not just a game.”

Icahn said the game was rigged. “He is right this is not a game,” Icahn said. “Michael has set it up in a way that he can’t lose -- and in a game you can lose. The board changed the rules in the middle of the game.”

In all, Dell invested his 15.6 percent stake in the company, valued at about $3.4 billion, and about $500 million of his $15.3 billion fortune, which makes him the world’s 60th-richest person, according to the Bloomberg Billionaires Index. Investors in MSD Capital Corp., Dell’s family office, invested an extra $250 million. Silver Lake and its limited partners invested about $1.35 billion, the firm’s biggest equity check ever.

Veto Power

While his stake in the private company will jump to 75 percent, he made concessions that give Silver Lake control over important management decisions, according to people familiar with the matter. The private equity fund, which will own the remaining 25 percent of the company, can veto any transaction or spending exceeding $500 million, the people said.

Dell’s and Silver Lake’s representatives declined to comment on the veto rule.

In addition, two Silver Lake partners -- Durban and Simon Patterson, who is based in the firm’s London office -- will sit on the newly constituted three-member board.

Dell said he is content with the deal and regards Durban as a friend.

“We couldn’t do this if we weren’t happy to have dinner together with our wives or to take each other’s calls on the weekend,” Durban said.

Forgo Profits

Their plan is to forgo profits by pumping money into research and development and to expand the company’s sales staff as they seek to become a broader-line supplier of cloud-computing gear to small and medium enterprises.

Rather than retreat from the rapidly shrinking PC business, Dell intends to go on the attack to regain the global market share lead by overtaking Hewlett-Packard Co. and Lenovo Group Ltd., including opening hundreds of retail stores in China, said two people familiar with his plans.

If all goes well, they would take the company public again in five to eight years, according to two advisers who requested anonymity because the time frame isn’t public.

“The capital structure gives us enormous possibilities to grow in cloud, mobile, Big Data, without thinking about the next quarter,” Dell said. He and Durban declined to comment on their exit plan.

Little Currency

After the LBO, the company will have little currency for acquisitions and other initiatives because the debt load will triple to about $18 billion, said people with direct knowledge of the company’s finances. Dell said he and Silver Lake are ready to inject more equity if needed.

Dell had had his fill of trying to satisfy public shareholders’ more short-term demands by mid-2012, said two advisers who requested anonymity because the information isn’t public.

Two years earlier, he’d succumbed to calls for Dell to focus on profitability over market share by backing away from cheaper PCs -- only to see its stock drop as revenue faltered.

The first tangible taste of going private came on June 15, 2012, when Southeastern Asset Management Inc., which was Dell’s second-largest shareholder with a stake of about 8 percent, proposed Dell undertake a buyout into which the firm would roll its shares, according to Dell’s proxy filing.

Dell told Southeastern he wasn’t interested after bankers at Goldman Sachs Group Inc. explained to him how complicated the deal would have been. A representative for Southeastern declined to comment, as did Michael Duvally, a spokesman at Goldman Sachs.

Golf Club

Just a few weeks later, on July 17, as Dell was leaving the stage at a Fortune magazine technology conference in Aspen, Colorado, Durban approached him. “Let’s get together in Hawaii,” Durban whispered.

On Aug. 10, the two met at Kukio, the massive golf club on the Big Island where Dell owns a house also known as the Raptor Residence. Worth about $50 million, it’s one of the most expensive properties in Hawaii, said Harold Clarke, a local real estate broker. Durban has a home in the neighborhood, too.

In some ways, they make an unlikely pair. Durban, 40, has the tanned, fit look of the runner and golfer that he is. He tends to wear the Silicon Valley uniform of khakis and no tie. People who know him describe him as “smart as hell” and aggressive.

Dell exudes a calmer confidence, still boyish-looking, if now a bit grayer and heftier. Even with his vast wealth, he is invariably described as a humble and unassuming -- many say boring -- family man. Dell and Susan, his wife of 24 years, have four children.

Beach Resort

Durban sketched out the LBO idea as they wandered for two hours through the grounds of the beach resort -- a practice Dell had picked up from walking meetings he’d had with Apple CEO Steve Jobs in years past.

“If I were you, I would consider taking Dell private,” Durban told Dell. “And I don’t think you need Silver Lake to do it.”

Dell sought the advice of another Hawaiian neighbor, KKR & Co. co-founder George Roberts. When Roberts confirmed that a deal might make sense, and that KKR might even make a bid, Dell decided to inform the board of his thinking. Roberts declined to comment for this story.

On the evening of Aug. 14, Dell phoned Alex Mandl, the lead director on Dell’s board in charge of CEO-related issues, to tell him of the LBO plan. Mandl informed the board, and within a few days he was named to head a special committee that would consider the Dell-Silver Lake bid while also trying to drum up other offers.

Due Deference

Relations between Dell and the board weren’t as they once were -- when directors had treated Dell with the deference due a manager once considered in a league with Henry Ford and Jack Welch. For the past two years some directors had asked Dell to sharpen his strategy and to improve the quality of his management team, according to two people close to the board.

Since achieving No. 1 market share in PCs in 2002, Dell hadn’t come up with a follow-up to his first big idea -- selling build-to-order PCs over the phone or online, rather than through retailers. Attempts to diversify beyond PCs, including such consumer devices as music players and smartphones, had foundered. By the time of Dell’s call to Mandl, the management team had missed its own revenue targets seven quarters in a row.

Dell paid scant attention to the board’s complaints, the people said, and the board never forced the issue -- until the buyout bid sparked a more aggressive approach.

Outside Firm

As the committee started evaluating Dell’s LBO idea, it took the unusual step in November of hiring an outside firm, the Boston Consulting Group, to provide a more realistic picture of the company’s health. BCG lowered Dell management’s forecast for PC industry profits by $10 billion over the next four years.

The special committee also became more assertive in demanding an upgrade of Dell’s management team. On Jan. 17, Mandl told Dell that the board would want him to hire a chief operating officer if the buyout wasn’t approved, according to people familiar with the board’s thinking. As the board considered further contingencies, one of the most-discussed options was to fire most of the management team even if it retained Dell himself, those people said.

Dell said he disagreed with the naming of a COO because his management was strong enough.

Tough Stance

As the bidding to take Dell private began, the board took a tough stance. It had initially set $14 a share as its minimum demand, and it rejected lower offers from Dell-Silver Lake and from KKR, which dropped out in December, said people familiar with the matter.

When Bloomberg News broke the news on Jan. 14 that Dell was in talks with buyout firms, Dell’s shares jumped 13 percent to $12.29, creating pressure on Dell and Silver Lake to raise the bid. They soon secured a $2 billion loan from Microsoft Corp. -- which had an interest in helping Michael Dell, one of its closest business partners, keep control of his company -- and increased their offer to $12.90 a share.

Not good enough, came the response. As weeks passed, and another sweetened bid was rejected, some Dell board members grew exasperated at the CEO’s refusal to ante up more money. They thought a few hundred million dollars were insignificant compared with his $15 billion fortune, according to people close to the board.

Share Cost

For Dell, it was a question of fairness, meaning he wanted Silver Lake to share the cost of any increase, Lee recalled. While driving in Florida on a weekend break in late January, the banker called Dell to persuade him to fund an increase by taking a discount on his shares.

“I’m not going to do that,” the CEO told Lee.

“I understand that, and I’m sympathetic,” said Lee. “But if this deal falls apart over 5 or 10 cents you’ll feel good for probably less than a minute, and then you’ll regret it for the rest of your life.”

Dell confirmed Lee’s account.

A few days later, Dell agreed to invest $500 million of his money to push the offer to $13.60. To get Silver Lake to go along with the 35-cent price boost, Dell agreed to let his shares be valued at $13.36, a discount that would increase Silver Lake’s equity stake.

The board remained cool. Dell and Durban came through again with the extra 5 cents the board was demanding, for a $13.65 per-share bid. The board approved their bid unanimously at 11 p.m. on Feb. 4.

Carl Icahn

If Michael Dell thought the tough part was over -- enter Carl Icahn. One of the pre-eminent corporate raiders of the 1980s, the 77-year-old billionaire investor had amassed stakes in companies such as RJR Nabisco Holdings Corp., Texaco Inc. and Time Warner Inc. so as to pressure their boards into making stock-lifting cost-cutting and divestitures.

On March 5, 2013, Icahn notified the board that he had accumulated a large stake and, in the first of his five proposals, demanded that Dell issue debt to fund a $9 per share dividend, or face a proxy fight for control of the board. Later Icahn, who never made a full counterbid, would team up with Southeastern. In January, the Memphis, Tennessee-based asset manager had proposed that Dell take on debt to finance a large dividend rather than to buy the company’s equity, leaving the company public.

They weren’t Dell’s only problem. T. Rowe Price Group Inc., Dell’s third-largest shareholder, announced it would oppose the buyout, an unusual move for an institutional shareholder. And Blackstone Group LP, another large buyout firm, was emerging as by far the most serious bidder yet with a $14.25 a share buyout offer.

Austin Compound

Dell invited Dave Johnson, Dell’s former chief strategy officer now at Blackstone, and Chinh Chu, the co-chairman of Blackstone’s private equity practice, to his 30,000-square-foot Austin compound, where sculptures line the driveway and the grass grows so thick that one visitor compared it to walking on a mattress. Over dinner, Dell said he would prefer to stay on as CEO, yet didn’t rule out supporting a superior proposal that didn’t include him.

Dell had reason to worry that Blackstone wanted him out of the picture. He had been contacted by people who said they had been approached by Blackstone or its advisers about running the company after a buyout.

“A number of guys called to say, ‘I wanted you to know I wouldn’t take the job,’” Dell recalled.

Issue Moot

The issue became moot on April 18, when Blackstone pulled out of the bidding after market-research firm IDC reported that PC sales had plummeted 14 percent in the first quarter, the steepest slump it had ever recorded. Christine Anderson, a Blackstone spokeswoman, declined to comment.

The board set July 18 for the shareholder vote. Dell had won the endorsement of Institutional Shareholder Services, an influential voice for institutional investors. Yet big shareholders including BlackRock Inc. still opposed the deal.

At 7 a.m. shareholders began filing into a section of office space at Dell headquarters in Round Rock that had been spruced up with faux white curtains tacked to the walls. While attendees munched on breakfast burritos, tensions were high in an adjoining conference room.

Dell and Durban were unlikely to have enough votes to secure passage. The board had adopted voting rules months earlier that were now coming back to haunt Dell’s bid. The shares of holders who failed to vote would be counted as no votes, and Michael Dell was barred from voting his stake, under the provision. The missing votes had ballooned to 27 percent, twice the amount in typical votes.

Stormed Out

At 8 a.m., Dell board member Mandl opened the meeting, then promptly adjourned it until a week later. When Durban stormed out of the meeting to go to the airport, JPMorgan’s Lee pulled him and Dell into an adjacent conference room.

Lee told Durban that the board might change the voting rules if they offered $14 a share, a price at which he said he believed the deal would get done. That triggered the nose-to-nose faceoff between Lee and Durban, who demanded, among other things, that Lee fire the vote-counting firm that had been surprised by the high number of abstentions.

“Do you think you are talking to a summer intern at Silver Lake?” said Lee, who is vice chairman of JPMorgan Chase. “Look, dude, these are the cards we were dealt, but at this stage that’s not happening, so you better just calm down.”

While Durban and Lee battled, Dell sat silently, head in his hands. Dell confirmed the account.

Price Increase

Durban declined to comment on the confrontation and said he called Lee the day after to start negotiating conditions for a price increase.

The second of the planned shareholder meetings, late on the afternoon of July 24, was also postponed as it was clear the LBO still lacked the necessary votes.

That same day, Dell and Durban agreed to raise the offer by 10 cents to $13.75, declaring it their “best and final” -- and made it contingent on the board agreeing to change the voting rules.

On July 31, Dell and Duberstein had their phone conversation and the deal was clinched. In exchange for a price increase, Duberstein told him, abstentions would no longer be counted as no ballots, and the record date was changed so that investors holding the stock as of Aug. 13 would be eligible to vote. That was key to getting more yes votes from arbitrage investors.

Final Bid

Two days later, a deal was announced with a special dividend payment of 13 cents to Dell shareholders, bringing the final bid to $13.88. Dell financed the $300 million bump with company cash, people familiar with the matter said, while agreeing to roll his stake into the deal at $12.51. He took another discount from the original $13.36.

The fourth and final shareholder vote was held on Sept. 12 in Round Rock, its passage a foregone conclusion with the new voting rules.

That evening, 150 guests gathered at Michael Dell’s home to celebrate, eating rib barbeque, drinking Lone Star beers and listening to the country-swing band Asleep at the Wheel. Advisers were wearing oversized blue metal pins, given them by Dell, depicting Road Runner, the cartoon character who always outwits his nemesis, Wile E. Coyote.

Dell stood with Durban and Lee when they spotted a rainbow, prompting some joshing about who owned the pot of gold at its end.

“The rainbow,” Dell said, “ends in Round Rock.”

Before it's here, it's on the Bloomberg Terminal.