Michael Dell set for collision course with investors over VMware plans

Michael Dell (Dell Technologies)

Dell Technologies will ask holders of "tracking stock" tied to its software company VMware to vote on its US$21.7 billion cash-and-stock offer to buy it back from them on 11 December, according to people familiar with the matter.

The move sets Dell on a collision course with some investors opposing the offer, including billionaire Carl Icahn, who owns 8.3 per cent of the tracking stock.

Icahn argued in an open letter to other investors this week that the deal would unfairly give US$11 billion in value to Dell's controlling shareholders, founder Michael Dell and private equity firm Silver Lake.

Dell issued the tracking stock in 2016 to buy data storage company EMC for US$67 billion because it could not pay for the entire deal in cash and did not want to add to its debt burden. EMC owned a majority stake in VMware, which Dell inherited.

The security "tracks," or depends on, the financial performance of VMware, and has been trading at a discount of more than 35 per cent to VMware's stock, which is steeper than what investment bankers advised Dell it initially would be.

This has emboldened investors such as Icahn to argue that Dell's offer undervalues the tracking stock.

Dell needs a majority of the holders of the tracking stock to approve the deal. An 18 October record date has been set, by which time investors needed to hold the tracking stock to be eligible to vote, according to the sources.

The acquisition of the publicly-traded tracking stock would result in Dell becoming a publicly listed company without an initial public offering (IPO). Dell disclosed on 3 October that it had met with investment banks to explore an IPO as a contingency.

Dell will explore the IPO further only if the tracking stock owners vote down the offer in December, the sources said, asking not to be identified because the decision to set a vote has not yet been announced. A Dell spokesman did not immediately respond to a request for comment.

Dell is offering US$109 in cash for each tracking share, up to US$9 billion in total, with the remainder payable with 1.3665 shares of Dell's Class C common stock for each tracking share. That is equivalent to a 41/59 cash-stock split.

Following the deal, investors who owned the tracking stock would collectively account for between 20.8 per cent and 31 per cent of Dell's ownership.

Icahn said that, based on his calculations, the tracking stock should be worth about US$144 per share, and that Dell's offer is actually worth only US$94 per share, because, in his view, Dell is inflating the value of its own privately held shares. The tracking stock ended trading on Thursday at US$94.49.

Dell has argued that its growth justifies a pre-transaction equity value for the company of US$48.4 billion.

The tech giant has also cited its regulatory filings that show the deal was the outcome of months-long negotiations between Dell and a special board committee representing the interests of tracking stock owners.

Dell can force investors to convert their tracking stock into common stock at a 20-per cent premium in the first year following an IPO, 15 per cent in the second year, and 10 per cent from the third year on.

It has argued that tracking stock investors are better off accepting its offer now, which carries a 29 per cent premium to the price of the tracking stock on 29 June, before Dell announced the transaction.

Shareholder advisory firm Institutional Shareholder Services Inc (ISS) said earlier this month that Dell should renegotiate the tracking stock deal.

ISS said it was reserving its final opinion until Dell files its definitive proxy statement, but added there were questions on whether the bid was worth as much as Dell claimed and whether it represented a fair premium.

Echoes of an old battle

Michael Dell has turned to deal-making to transform his company from a PC manufacturer into a broader seller of information technology services, ranging from storage and servers to networking and cyber security.

The tracking stock battle has echoes of the US$24.9 billion deal that Dell and Silver Lake clinched to take the company private in 2013, a transaction that Icahn also opposed, though he managed to secure a slight bump in the buyout offer.

Other investors that have opposed the tracking stock deal include P. Schoenfeld Asset Management LP, which earlier this month asked Dell to raise its offer by 20 per cent. Hedge fund Elliott Management Corp is also not satisfied with Dell's offer, sources have said.

If the deal goes through, Michael Dell would own 47 per cent to 54 per cent of the combined company and Silver Lake would own between 16 per cent and 18 per cent.

Going public would give Michael Dell and Silver Lake the ability to eventually sell down their stakes, even though they have said they have no plans to do so.

As a public company, Dell could also more easily use its stock as currency for acquisitions. While its debt has dropped from US$57.3 billion following the EMC deal to US$50.3 billion, it remains heavily indebted.

The company continues to pay down debt and has told investors it aims for an investment-grade rating sometime next year.

(Reporting by Greg Roumeliotis and Liana B. Baker in New York; Editing by Leslie Adler and Nick Zieminski)