Dell’s Offer To Buy DVMT Shares At A 42% Discount: An Insult DVMT Shareholders Should Reject! Says Carl Icahn

Dell Presentation on DVMT Buyout

Q3 hedge fund letters, conference, scoops etc

Summary

Dell wants to buy your DVMT shares for $109: It’s an insulting offer that shareholders should reject!

Two years ago Dell and its bankers disclosed that the DVMT tracker would trade at no more than a 5 to 10% discount to VMW shares.1

But now they are recommending we accept only $109 per share while VMware shares sell at $1522.

More importantly, the $109 they are offering is not actually $109 because DVMT shareholders would have to take Dell stock that is being highly overvalued in Dell’s calculation.

By our calculation, the value they are offering is only $90, a 42% discount by our math. See slide 6.

If Dell’s deal is allowed to happen, instead of owning credible and highly desirable VMware, we will own vastly inferior and over-levered Dell.

To even consider accepting such an uneven and undesirable trade, DVMT shareholders would have to be offered a PREMIUM over the current VMware price, not a discount.

Your vote is important.

Vote AGAINST the Michael Dell/Silver Lake buyout scheme today!

Transaction Proposal

• On July 2, 2018 Dell agreed to purchase all of the outstanding DVMT shares for a theoretical price of $109 per share, in cash and newly issued Class C Common shares of Dell, subject to a $9 billion cash cap.
• Although Dell claims the $109 offer represents a 29% premium to DVMT’s closing price prior to the announcement, they fail to highlight that the $109 is a 27% discount to the true economic value of the shares.1 But in reality, their offer is much worse than only a 27% discount because it is only partially payable in cash and the $109 figure relies on the embedded assumption that Dell will trade for $79.77 following the exchange –a wildly optimistic assumption for a company whose core business faces secular headwinds and whose controlling shareholders have a demonstrated track-record of pernicious governance.
• To achieve their valuation, Dell has used great imagination and financial engineering. For example, in coming up with their $109, Dell has used magical accounting to convert the tracking stock they are buying from us, which now trades at $992, to the VMware price of $1522, thus capturing an incremental value of approximately $10 billion for their offer simply by waiving a magic wand.
• As recently as April 3, 2018, Dell had an independent firm value its Class C Common shares at only $49.28 per share for the purpose of equity awards and repurchases. Going back less than a year, on September 13, 2017 Dell valued the shares at $32.70 in a tender offer to purchase Class C shares3. They are now hoodwinking DVMT shareholders by offering the same shares, valued at $79.77, as currency to buy your stock.
• As shown below, we believe the Dell offer they claim is worth $109 is worth only $90 per share, a 42% discount to DVMT’s intrinsic value!

Situation Review

• On July 2, 2018 Dell Technologies (“Dell” or the “Company”) announced a merger agreement (the “Merger”) to repurchase all of the public Class V Common stock of the Company (“DVMT” or the “tracking stock”) formerly issued in conjunction with Dell’s acquisition of EMC Corporation (“EMC”) in 2016.
• We believe the transaction is an opportunistic scheme designed to indirectly transfer ~$11 billion of value from the tracking stock shareholders to the existing Class A and Class B stockholders, including Michael Dell and Silver Lake Partners.1
• By our math, the stated offer price of $109 per share is in reality closer to $902per share, a 42% discount to the current value of DVMT of $1543as implied by the public markets.
• Although Dell and its advisors have repeatedly referenced conducting an IPO instead of the Merger, which all shareholders know could be followed by a forced conversion of DVMT into Dell stock, these are scare tactics and should be dismissed.
• In reality, Michael Dell and Silver Lake are stuck between a “rock and a hard place.” IPO’ingthe Company and forcing a conversion of DVMT creates massive uncertainty and substantial litigation. On the other hand, simply doing nothing perpetuates and worsens an unsustainable capital structure that is essentially “uninvestable.”
• The only viable paths forward are to significantly improve the offer price to one that is fair, or for the proposed transaction to be voted down by a wide margin.

Due to these and other reasons described herein, VOTE AGAINST Michael Dell and Silver Lake’s self-serving buyout offer.

• Following their 2013 going-private transaction, in 2015 Dell’s controlling stockholders devised a plan to purchase EMC Corp., a rising data infrastructure and software company, in an effort to offset the slow demise of Dell’s legacy hardware business.
• To fund the massive $64 billion acquisition, Dell offered EMC shareholders a tracking stock to cover $10 billion of the purchase price, initially intended to track 65% of the economics of VMware, a high growth subsidiary of EMC at the forefront of cloud, networking and security infrastructure software.
• Despite Dell’s and its investment bankers’ assumption that DVMT would trade within 5-10% of VMW, since its first trading day, DVMT has traded on average 35% below VMW due to an atrocious governance structure put in place by Michael Dell and Silver Lake.1

• On the same dayas the closing of the EMC acquisition, when the board should have been laser-focused on creating value for all Dell shareholders, including DVMT shareholders, Dell’s board instead approved a $1 billion repurchase program to begin locking in value rightfully belonging to DVMT shareholders implying they knew the DVMT shares would trade at a discount.
• Through discounted repurchases of DVMT shares funded through sales of VMW shares, the existing shareholders (other than tracking stock shareholders), including Dell and Silver Lake, have already indirectly captured an estimated $650-700 million of value.1
• Dell is now proposing a transaction to repurchase all DVMT shares, a massive transfer of approximately $11 billion that would indirectly benefit Dell’s controlling stockholders, Michael Dell and Silver Lake, at the expense of DVMT shareholders.

• Although most tracking stocks tend to trade within a ~10-15% discount to their underlying asset1, DVMT has traded at a significantly wider discount due to the convoluted capital structure,horrendous corporate governance terms created by Michael Dell and Silver Lake and Dell’s massive leverage.
• We believe this structure was an attempt to create a wide discount between DVMT and VMW, and it should be noted, it was very successful.

Governance Low-lights

• Forced conversion. Following an IPO of its Class C shares, Dell may be able to force the conversion of DVMT shares into Class C shares (including a premium depending upon timing).
• Dividend restrictions. If VMware were to pay a dividend, Dell is under no obligation to distribute the cash to DVMT shareholders. With the approval of the Capital Stock Committee (“CSC”) Dell may even reallocate those funds!
• Substitute VMW shares. With approval of the CSC, Dell has the right to substitute the VMW shares held within the Class V group with other assets of similar value, whether or not DVMT owners agree. This could potentially result in the delisting of DVMT due to NYSE rules2.
• Capital Stock Committee. A committee of three independent members of Dell’s board (who maintain minimal liability under Dell’s Charter) is the only group deemed to represent the rights of DVMT shareholders.

Sowing Fear

• For much of 2018, Dell has pursued a campaign of fear-mongering, pressuring DVMT’s price by implying they will either (a)act upon the atrocious governance rights by IPO’ingDell’s Class C shares and forcing DVMT shares to convert, or (b)simply maintaining the status quo, indefinitely denying DVMT stockholders their true value.
• During the first year following DVMT’s IPO, the total dollar discount between DVMT’s market capitalization and the market value of the VMW shares to which they are economically linked was about ~$5.5 to $6 billion.
• Interestingly, after the first reported meeting between Michael Dell and Egon Durban (Dell director and Partner of Silver Lake) in which they spoke of, among other things: (1)A potential Class C IPO, (2)A combination of Dell and VMware in which public VMW shares and DVMT shares would be converted to Class C shares, and (3)A large scale joint repurchase program between Dell and VMware1, the discount began rising, increasing by nearly $1 billion over the next three weeks.

• On February 2, 2018, Michael Dell and Silver Lake made their threats explicit by announcing a strategic review of the business, shamelessly adding to their press release “we do this from a position of strength”–a subtle but clear message to DVMT shareholders2.
• Even worse, Dell’s CFO audaciously boasts about “opportunistic opportunitiesin the market to take advantage of the discount between the two securities” all at the expense of DVMT shareholders3.

The Absurd IPO Threat

• Although Dell continues to push the idea of a potential IPO of Class C shares, the reality of the situation is much different.
• Unfortunately for Dell, any normal IPO of Class C shares would almost certainly trade at a severe discount to the numbers they wish you to believe.
• Ultimately the forced conversion would result in DVMT shareholders owning a far greater percentage of the proforma company than either Michael Dell or Silver Lake would accept, making such a strategy dubious at best.
• Michael Dell and Silver Lake knows this, which is why they have their investment bankers telling the public that it might complete a “skinny IPO” in which few Class C shares are sold in order to create an artificially high price for the stock.
• But Dell also knows that any attempt to manipulate the IPO process will be met by us with immediate litigation.

Dell IPO Would Undoubtedly Include:

1. A Massive Governance Discounton limited shareholder protections and majority shareholders with a polluted track-record.
2. A Conglomerate Discountfor partially owned assets and a complex corporate structure.
3. An Unmeasurable Dilution Overhangdue to the roughly $20 billion in imminently possible forced conversion of DVMT shares.

We believe that a forced conversion of DVMT shares in conjunction with a Dell IPO could result in irreparable damage to DVMT shareholders, could be seen as retaliatory by the courts, and could ultimately result in either an injunction or substantial damages against Dell and its owners.

Dell’s Overvaluation of its Class C Shares

• Dell’s core business has historically been comprised of PC sales, which still make up an estimated 50% of overall revenues.1
• But more recently the PC industry has become commoditized due to the rise of low-cost global players and increasing competition. Worldwide units have fallen by 29% since peaking in 2011 per Gartner.
• Setting aside governance, corporate complexity, over-leverage and other issues, Dell’s core business is facing secular headwinds and would very likely trade poorly in an IPO.

• Even Dell’s own board valued the Class C common stock at only $33.17 per share2for valuing severance of a terminated employee as recently as February 2, 2018, a 58% discount to their new forecast!
• Further, prior to its acquisition, EMC’s core business traded at an implied forward EBITDA multiple of ~4.5x implying the core Dell business is worth just $1.6 billion.3Unsurprisingly, DVMT’s current trading price implies an IPO price almost 30% below that used by Dell in its forecasts.

While DVMT continues to trade at a ~35% discountto the VMware shares they are supposed to track, Michael Dell and Silver Lake are proposing a conversion ratio that values Dell using the full value of those same VMW shares.

In other words, not only does Dell want to acquire your DVMT shares at a 30% discount, but incredulously, they also want to pay for it by using Dell equity at an inflated valuation that assumes the full economic value of the VMW shares!

The Majority’s View:

“A full 87% of [Deutsche Bank conference] attendees believed that if the vote were to occur today, Dell’s existing bid would be voted down” – Deutsche Bank Securities research October 21, 2018

“In many ways, the IPO alternative seems suboptimal for both sides” – Institutional Shareholder Services Inc., research note October 5, 2018

“The Biggest Winner of Dell’s Public-Market Return? Michael Dell” – Bloomberg Deals, July 2, 2018

Legal Hurdles for Dell’s Controlling Shareholders

• By approving such a transaction, we believe that Dell’s independent directors must have been misinformed by Dell or Silver Lake’s advisors, or otherwise unquestionably they breached their fiduciary duties to DVMT’s shareholders.
• Assuming Dell loses the December 11 vote, if Dell were then to attempt an IPO and forced conversion of DVMT shares, certainly causing DVMT shareholders irreparable harm, we believe applicable law will allow shareholders to pursue an injunction and/or substantial damages.
• The Delaware courts are clear that controlling stockholder transactions must be reviewed under the stringent entire fairness standard, not business judgment, unless certain procedural safeguards are satisfied. Even if Dell obtains the shareholder vote, given the threatening tactics used in solicitation of the vote, we do not believe the vote will shield the controlling shareholders from entire fairness litigation.
• The merger transaction requires the approval of the majority of the outstanding DVMT shares. This was the same threshold required in Dell’s going-private transaction, but then at the 11th hour, Dell changed the vote to the easier standard of majority of those voting. Luckily, Delaware law has evolved since 2013 and if Dell tries this trick again, we believe the transaction will be subject to entire fairness.
• If Dell tries to force an IPO conversion we believe the Board must treat such a transaction as a conflicted controlling stockholder transactionand obtain protections for the DVMT stockholders, otherwise the Board’s decisions will be reviewed under the entire fairness standard.
• Against the backdrop of DVMT stockholders rejecting the proposed DVMT merger transaction, we believe it will be very difficult not to conclude that the forced IPO conversion was pursued in retaliation against DVMT stockholders.
• Suffice it to say, we reiterate that we believe the threat of a forced IPO conversion is empty, no matter what Michael Dell and Silver Lake claim.

The Empty “Status Quo” Threat

• Dell’s second threat, to essentially do nothing and keep DVMT stockholders from realizing their true value, is equally without merit simply because Dell is not in a financial position to do so, and destroys value for its controlling shareholders with every day that goes by.
• The extended global recovery of recent years has allowed Dell to portray a turnaround story, but the Company’s core hardware business is admittedly cyclical. Although Michael Dell likes to paint a picture of financial opportunity, the PC/peripheral hardware business has in effect become commoditized. Dell faces stiff competition from low-cost providers without having any competitive advantage.

• Dell is really just an over-levered secularly challenged business facing massive competitive threats. The next downturn could significantly impair the company’s cash flow and with over $2 billion in annual interest payments1, it is unclear whether its equity holders would even weather the storm.
• As such, it is no surprise that Dell’s controlling shareholders are desperately trying to get access to VMware’s pristine balance sheet and steady stream of free cash flow.

Dell’s Core Business in Management’s Words:

“Given current market trends, we expect that the demand environment will continue to be cyclical and that competitive dynamics will continue to pressure our CSG business.” –Dell Q2 2019FY 10Q.

“There is a risk that Dell Technologies’ competitors may provide products that are less costly, perform better or include additional features that are not available with Dell Technologies’ products.” –Dell Q2 2019FY 10Q.

“It’s a tough market. It’s a challenging market. It’s a cyclical market.”–Dell CFO comments, Deutsche Bank Conference Sept, 2016.

VMware’s True Value

• Unlike the decaying business of PC hardware, VMware is at the forefront of the rapidly growing cloud infrastructure and business mobility software space.
• We believe that at VMware’s current trading price the market is underappreciating VMW’s true earnings power as the uptake and ever increasing complexity of the cloud-native world will drive sustainable long-term growth.
• Based on IBM’s recent offer for Red Hat, a deal we believe should have a comparable valuation to a future VMWare deal, VMW should be worth $300 per share.1
• Simply using the 2023E forecasts provided by Dell management2, it is easy to see how VMware could be worth upwards of $250 per share in just a few years.

The Path Forward

• Through this transaction, Dell’s controlling shareholders are attempting to indirectly increase their economic ownership in VMware from 32% to 64%1. At the same time, by accepting this deal, DVMT shareholders’ interest in VMware will decline from 50% to 17%.
• Dell will further gain access to VMW’s balance sheet, cash on hand, and ongoing free cash flow, all at an $11 billion discount.
• Further, by increasing Dell’s ownership in VMware Michael Dell and Silver Lake are hoping to receive a higher blended multiple for the overall Dell business when they ultimately sell or go public.
• Although this will indirectly benefit Michael Dell and Silver Lake, it is directly counter to their original promise of allowing DVMT shareholders to participate in the upside of VMware, a competitively advantaged, rapidly growing, high margin, capital-light business.

For these reasons, Dell should pay a fair price consistent with the promises made and with the benefits they will receive.

Article by Carl Icahn