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Why Is Dell Heating Up? Shareholders Feel Burned

Richard Satran

Dell's deal to buy itself out in a private-equity backed transaction was a brilliant move for investment bankers and Dell managers who thought the stock was so cheap it was a steal--so it's no surprise that activist shareholders have leaped onboard to thwart the transaction.

What's wrong with a Dell deal that pays shareholders 37 percent more than their shares were worth before the bid was disclosed? Indeed, why should anyone oppose the move by America's struggling No. 1 computer maker to reinvent itself as a private company? Because the $24 billion buyout by technology investment company Silver Lake and Dell's top management still doesn't pay shareholders enough, critics say.

Two activist hedge fund investors, Southeastern Asset Management and Carl Icahn, have collectively bought 13 percent of Dell and say a buyout at this level would be "substantially undervalued." Activists investors would say that, because that's their business. More unusual, a major mutual fund company, T. Rowe Price, which owns a small amount of Dell stock, has opposed the deal--a rarity since mutual funds are loathe to oppose managements, especially a powerful CEO like Michael Dell. Pzena Investment Management, an adviser to mutual funds, has also gone negative on the deal.

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They note that Dell's deal uses the company's own available cash and a $2 billion loan from Microsoft that means Dell's buyers will have to pay only half of the $9 the company traded at before the deal was launched. The offer from Michael Dell and Silver Lake is $13.65 a share. The outside investors say the true value should be more like $18 to $24.

"This kind of deal is really going to turn off public investors in the stock market," says Mark Germain, chief executive officer of Beacon Wealth Management. "They want to realize long-term value and they lose that in these kind of takeovers."

Even though the buyout offer from Silver Lake and Dell managers was 37 percent above the premium to its stock-market value, Dell's stock had recently dropped to a multiyear low of just under $9 a share, half its 2012 high of nearly $18. The $13.65 buyout offer is below the $14 a share that Dell should already be worth this year, said Standard & Poor's Equity Research in a recent report. Shareholders have yet to see the benefits of the company's shift from personal computers to other, more profitable businesses. "Expansion in the servers, networking, and services areas should lift sales and margin potential over the long term, in our view, " said the recent S&P report.

Investors have watched Dell languish for nearly a decade as Apple and other companies have passed it by with hot smartphones, notebooks, and tablets. Dell has put out me-too products but has never been a true competitor to Apple. Still, Dell has an enviable network of sales representatives in the corporate world, giving it a channel to sell far more services and higher-end products, especially cloud-based solutions and security.

Even its stodgy PC business is likely to benefit in an economic rebound.

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"We've been five years in the economic doldrums and now that things are picking up, so are the private equity deals," says Steve Henley, a consultant from CBIZ MHM, LLC, who heads the company's national tax practice. Technology was worst performer on the S&P's list of major equity sectors. Computers and peripherals were the weakest segment in tech. Internet services was the strongest.

Backers of the Dell management-led Silver Lake deal say the company needs to go private, in part because its fast-deteriorating PC business is generating less cash, falling from $5 billion to $3 billion over the past year. Investors are worried the company will take itself private before the new initiatives and acquisitions hit the bottom line. Dell has already made those moves in hopes of selling new services such as data protection and cloud-based software services through its sales network. "Technology companies can create a lot of cash because the products they produce are in demand and their key value is intellectual property that does not add to their cost as they produce more," says Henley. Dell's legacy computers and peripherals have continued to spin profits, although at a declining rate, and the company has been slow to make the transition to faster-growing parts of the market.

In a sign that times have changed, it's the activists, not management, who are trying to keep Dell a publicly traded company that pays a large dividend to spend down its cash and keep loyal shareholders happy. Michael Dell and his management group want to take all of the equity themselves, and would most likely sell the transformed company back to the public later at a profit when tech stocks command higher valuations.

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Other computer makers and investment firm Blackrock Investment Management are also reported to be interested. With so many parties circling, and outside investors now owning as much of the company as its founder, it's likely to be a long fight. Icahn has vowed "years of litigation."

None of this will launch Dell back to the $100 billion price tag it once commanded. But it's already lifted the stock and put the much-ignored PC company back into the public eye for the first time in years. Expect more of the same to come.

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