Last week, The Wall Street Journal reported that Dell (ticker: DELL) was weighing various options for the stake, including a potential spinoff to current Dell holders.
As of Monday morning, Dell has a market value of $39.6 billion; the company’s stake in VMware (VMW) is worth $50.7 billion. Dell has about $40 billion in debt, excluding its equipment finance unit, mostly from its 2016 acquisition of EMC.
As my colleague Andrew Bary noted in Barron’s over the weekend, the decision on what to do largely rests with founder Michael Dell, who has just over 52% of Dell’s outstanding equity, but 75% voting control. The investment firm Silver Lake holds a 14% stake, and 20% of total votes. The public owns the remaining 34% of the equity, but just 5% of voting interests.
In a research note on Monday, Deutsche Bank analyst Jeriel Ong provided a breakdown of seven options for how Dell can proceed from here.
Increase its stake in VMware: Ong contends Michael Dell would rather own VMware outright then divest it. But he notes that given the company would likely have to pay a premium over the current stock price, this approach would likely cost Dell $16 billion if you assume a 30% premium. While at first blush that seems like a non-starter given Dell’s already considerable leverage, Ong noted that the combined company could also use VMware’s cash flow to pay down debt, leading to potentially lower leverage ratios for the combined company.
Dell sells partial stake, keeps majority control: “We see this as a lower-probability scenario for several reasons,” Ong writes. “First, this scenario would result in taxes on capital gains. Second, Dell could have done this at any time in the past few years, so we would question ‘why now.’”
Dell spins partial stake, keeps majority control: Ong finds this unlikely, since it would not address Dell’s leverage issue, and might not cure the discount.
Dell sells stake to below 50%. Dell would likely need to pay taxes on a share sale, but would have cash to pay down debt. “We believe with a stronger balance sheet, they would be in a better position to announce an ongoing dividend or a more robust share repurchase plan,” Ong writes. “They may also play a larger role in consolidating servers, storage, or PCs as they would have more flexibility to take on incremental leverage for another deal.”
Dell spins VMware shares to holders, reduces stake below 50%. The issue with this approach is that does nothing to shore up Dell’s balance sheet. One option would be for VMware to take on debt and then to pay a special dividend to Dell, as outlined in Bary’s story in the magazine.
Dell sells its entire VMware stake, generating substantial cash that could be used to pay down debt and other purposes. “Overall, we believe this option is low on Dell’s priorities because we really can’t understand why they would not have done this sooner if this was a high-tier consideration,” Ong writes.
Dell spins its entire stake. He says that approach would likely address the discount, but it does nothing to shore up Dell’s balance sheet. Also this approach is not possible before September 2021 for tax reasons.
Ong maintains a Buy rating on Dell shares, and on Monday raises his target price to $60, from $55. “Overall, we believe that this past week’s move up in Dell’s shares is a first step in acknowledging the valuation discount that we believe that continues to exist in the shares,” he writes.
On Monday, Dell was up 2.5%, to $53.57. VMware was up 2.3%, to $149.91.
Write to Eric J. Savitz at firstname.lastname@example.org