Dell delisting, and share valuation concerns

The story of Dell represents the story of American enterprise. Started in a college dormitory room, and making products that the technology age devoured with passion, the company wasted no time in catapulting itself to a market capitalisation of more than $100 billion.

For some time, it was also the darling of the stock market. In stark contrast, last week, Dell unveiled a buyout deal to take the company private. The $24.4-billion buyout would be financed with Michael Dell’s cash and equity, cash from Silver Lake, and a $2 billion credit line from Microsoft.

Four major investment banks — Merrill Lynch, Barclays, Credit Suisse and RBC Capital Markets — are financing the debt. The primary intention behind the go-private move appears to be to escape the harsh glare of the markets with iffy quarterly results and to focus on strategy without being hounded by analysts.

It could well be a combination of many factors, but the fact that cannot be denied is that Dell has been bleeding because of the shift in the market to smartphones and tablets and its inability to play catch-up. Further bleeding could have only hammered its stock price. While the buyout can help it avoid quarterly analysis and questions, delisting could also prevent Dell from building a war-chest for future acquisitions.

Leveraged buyouts

As in most leveraged buyouts, the price being offered — $13.50-13.75 a share — is being questioned. Southeastern Asset Management — which has some stake in Dell — hopes to make life difficult for Michael Dell. As the largest outside shareholder of the eponymous company, it says it doesn’t support the cheaply priced buyout led by the billionaire founder and will vote against the proposed deal. Southeastern values the company at $23.72 a share, greater than the $13.50-13.75 a share that Dell and his partners are offering.

The strong objection from Southeastern can be justified, considering the fact that it has lost its money in other investments and would not want a repetition. Any valuation is subject to a number of assumptions and judgment due to which differences are bound to occur. Accounting standards consider the quoted market price to be the best indicator of fair value — the Dell buyout deal meets this test, as the price offered is at a premium to the existing market price.

Accounting practices

The market price is supposed to be an encapsulation of a number of tangible and intangible factors. Dell has had its share of run-ins with the regulators on accounting practices. Till mid-2005, as per US GAAP, stock options granted to employees did not need to be recognised as an expense on the income statement, although the cost was disclosed in the notes to the financial statements. This allows a potentially large form of employee compensation to not show up as an expense.

However, this rule was changed to state that companies must begin showing stock options as an expense no later than the first reporting period beginning after June 15, 2005. Many companies — Dell among them — sought to reassure shareholders that they would suffer no dilution through the issuance of stock options, vowing to buy back as many shares as they issued through options.

In 1996, Dell came up with a strategy to deal with that. It began to speculate in options on its own stock. It bought call options allowing it to purchase shares at a fixed price several years out. And it sold put options, requiring it to purchase stock at a preset price years later if the other party wanted to sell.

When the stock was rising, the strategy worked. But after the share price fell, Dell was in trouble. Later, Dell pumped up profits by taking undisclosed payments from Intel for agreeing to use only Intel chips in its computers. When the payments stopped, Dell was left holding the baby.

SEBI rule

In India, the Securities and Exchange Board of India (SEBI) came out with a rule that listed companies need to have a minimum of 25 per cent public shareholding, tempting promoters with more than 75 per cent shareholding to either go private or dilute their shareholding. The history of delisting in India has been insipid. More than 200 listed companies have delisted, with a vast majority due to mergers and acquisitions. Valuation of shares has been the bane of many a delisting attempt.

Cadbury has met with stiff opposition to its offered price of Rs 1,340 while India Securities met with opposition as its shares were infrequently traded. Minority shareholders who have litigated against companies in the past will find additional succour in the newly minted Companies Bill that permits class-action suits by a group of minority shareholder coming together. Companies intending delisting could keep in mind the diktat “It’s all in the valuation, stupid!”.

(The author is Director (Finance), Ellucian.)

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