Mon 10/22/2018 11:48 AM
Takeaways
 
  • Should Dell pursue the IPO “cram down” option, the company can theoretically postpone a legal showdown with Carl Icahn and his fellow partners to a later date (likely a year from now) when the conversion is actually forced upon the tracking stockholders.
  • DVMT shareholders have argued that Dell’s current $109 per share offer undervalues the tracking stock by $11 billion. This argument compares Dell’s offer to the 50% economic interest that the tracking stock has in shares of VMware common stock.
  • However, in the context of Dell’s battle with DVMT shareholders, an alternative comparison is between Dell’s current offer and the value that DVMT shareholders will likely derive in a scenario where Dell opts for an IPO of its Class C shares and then forces a conversion of the tracking stock a year from now.
  • Reorg M&A’s analysis, using the numbers published by DVMT shareholders, reveals that DVMT holders stand to derive significant value even if Dell pursues an IPO “cram down” a year from now. This means that DVMT holders opposing the merger transaction retain the edge going into the Dec. 11 shareholder vote.

The battle between Dell and those opposing the transaction is likely to intensify in the run up to the Dec. 11 vote to approve the Class V buy-in transaction.

Dell has already floated the idea of exploring a potential IPO of its Class C shares as a “potential contingency plan” in the event that the Class V transaction is not consummated. Carl Icahn has termed Dell’s “scare tactics” as part of a broader “fear-mongering campaign.”

In his letter to fellow DVMT holders, Icahn argues that Dell’s $109 per share price for the tracker is well below the fair value estimate. According to DVMT shareholders, the Dell tracker should receive cash consideration of $130 per share.

Both Icahn and PSAM in their letters and presentations have focused extensively on Dell’s threat of an IPO “cram down,” a provision in Dell’s charter that would allow the company to move ahead with IPO plans without conversion of Dell’s tracking stock into Dell’s Class C common stock.

Icahn argues that if Dell invokes the forced IPO conversion, Dell’s board must treat such a transaction as a “conflicted controlling stockholder transaction” and obtain protections for DVMT stockholders, otherwise the Board’s decisions will be reviewed under Delaware’s entire fairness standard.

However, it is not clear if Dell’s tracking stock policy documents or the original merger agreement at the time of the Dell/EMC merger constrain Dell’s power to unilaterally pursue an IPO of its Class C shares irrespective of approval from DVMT holders.

For instance, the Dell-EMC merger’s final prospectus flags risks for Dell’s tracking stock, stating that “there may be inherent conflicts of interests between the DHI Group and the Class V Group” and that “decisions deemed to be in the best interest of Denali and all of Denali’s stockholders may not be in the best interest of a particular group.” Importantly, the document notes that Dell’s board, in its sole discretion, may convert all of the tracking stock shares into Class C shares based on a ratio that takes into account the market value of the two securities during the ten-day period before the announcement, and apply a conversion premium to which DVMT holders are entitled to.

That provision, however, does not mean that a potential decision to convert tracking stock shares to Class C shares will not be subject to a legal challenge. According to Jason Saltsberg, an attorney at Olshan Frome Wolosky who specializes in securities law, the fact that Dell’s charter allows the Board to convert the tracking stock into Class C shares doesn’t necessarily mean that an action to that effect would be automatically above board. “[I]n making the decision to convert, Dell will likely want to obtain a fairness opinion and have the process be led by an independent committee to ensure Dell is shielded from a potential lawsuit.”

From a procedural standpoint, should Dell opt for the IPO “cram down,” it is unlikely that holders of Dell’s tracking stock can block that decision. It is only when Dell invokes the provision to convert the tracking stock into Class C shares (post the IPO) that Icahn and other tracking stockholders will have standing to move Delaware courts for relief.

Even then, the plaintiffs - in this case the tracking stockholders - face a higher burden to compel the court to apply the “entire fairness” standard of review vis-a-vis the conversion decision.

Thus, Dell can theoretically postpone a legal showdown with Icahn and his fellow partners to a later date when the conversion is actually forced upon the tracking stock holders. That decision is likely to take place at least a year from the date when Dell completes the IPO of its Class C shares.

Financial Impact

In presentation by an activist investor it has been argued that Dell’s current $109 per share offer undervalues the tracking stock by $11 billion. The presentation compares Dell’s offer to the 50% economic interest that the tracking stock has in shares of VMware common stock. However, in the context of Dell’s battle with DVMT shareholders, an alternative comparison would be between Dell’s current offer and the value that DVMT shareholders will likely derive in a scenario where Dell opts for an IPO of its Class C shares and then forces a conversion of the tracking stock into the former one year from now.

Based on these numbers, Reorg M&A estimates the potential value of the tracking stock in this hypothetical scenario. Figure 1 illustrates Reorg M&A’s financial calculations.

Figure 1: Best Case Scenario Under a Forced IPO Conversion a Year From Now
 
 
 


As Figure 1 illustrates, a scenario where VMware’s share price is trading at $160 a year from now and the tracking stock is trading at a discount of 36%, a potential conversion (with a 15% conversion premium) will entail converting the tracking stock into Class C shares at a ratio of 1.7028.

DVMT shareholders would end up with a 26% ownership of the consolidated Dell entity. With Class C shares trading at $69.16, total value accrued to DVMT holders would stand at $28.9 billion compared to Dell’s current cash plus stock offer valued at $21.7 billion.
 
Figure 2: Sensitivity Analysis
 


Figure 2 above presents the amount per share that DVMT holders stand to lose if they vote for the merger transaction as against letting Dell pursue an IPO “cram down” a year from now.

For a $160 VMware share price and 36% discount rate a year from now, the difference would amount to $36.32 per share of the tracking stock, meaning DVMT holders would lose that per share amount if they vote for the merger transaction on Dec. 11 instead of letting Dell go ahead with a Class C IPO and a forced conversion a year later.

From Dell’s perspective, this difference is significant and could mean that it may be hard for the company to bring around DVMT holders to accept the current offer when the latter could well extract greater value 12 months from now. It has been argued that Dell should make an offer of $130 per share for the tracking stock.

As Figure 2 illustrates, for Dell to bring parity between its current offer of $109 per share with the value that DVMT holders could receive a year from now, the company will have to offer somewhere between $145 and $149 per share. This calculation assumes $160 VMWare share price 12 months from now and a tracking stock discount ranging between 34% to 36%. In other words, DVMT holders that are opposing the merger transaction retain the edge going into the Dec. 11 shareholder vote.

-- Shrey Verma
 
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