Will Dell Shareowners Get Fair Value?

(Reuters/PRNewswire) Southeastern Asset Management, Inc. the largest outside shareholder of Dell Inc. (NASDAQ: $DELL), today announced that it has sent a letter to the Board of Directors of Dell noting that it believes Dell’s proposed go-private transaction grossly undervalues the Company, and will not vote in favor of the transaction as currently structured.  Southeastern intends to retain and avail itself of all options at its disposal to oppose the announced transaction, including, but not limited to a proxy fight, litigation claims and any available Delaware statutory appraisal rights.  Southeastern beneficially owns on behalf of its investment advisor clients approximately 8.5% of Dell’s outstanding shares (including options).  Southeastern filed the letter with the SEC in an SC 13D today.

In its letter, Southeastern notes that it believes that the proposed transaction, under which Dell’s public shareholders would receive only $13.65 per share, clearly represents an opportunistically-timed bid to take the company private at valuations far below Dell’s inherent value, and deprives public shareholders of the ability to participate in the future upside of the Company. Excerpt below:

Southeastern believes that straightforward, modest valuations of Dell result in per share valuations vastly in excess of the $13.65 offer price.  Net cash per share after deducting structured debt within Dell Financial Services (DFS) is $3.64.  Dell Financial Services has a book value of $1.72 per share.  In addition, since Michael Dell resumed his role as CEO in 2007, the Company has spent $13.7 billion or $7.58 per share on acquisitions intended to transform the Company into a sustainable IT business and lessen its reliance on the PC business. During Dell’s June 2012 analyst day, Dell Chief Financial Officer Brian Gladden said that in aggregate the acquisitions to that point had delivered a 15% internal rate of return. The Company has neither taken nor discussed the need to take any write downs of these acquisitions.  We therefore conservatively believe the acquisitions are worth a minimum of their cost.  Taken together, these items total $12.94 per share before we even look at the other businesses.

The current bid therefore places a value of less than $1.00 per share on the remainder of the Company.  By any objective measure, that is woefully inadequate.  Specifically, none of the following are accounted for above:

• As one of the dominant players in X86 servers, including the DCS division serving  “hyperscale” customers, the server business alone is easily worth $8.0 billion, or $4.44 per share.  This value excludes the results of  SonicWall, Wyse and Quest which are included in the “Acquisitions” total above and which are carried in the “Servers and Networking” division.
• The part of the “Services” segment not captured in the “Acquisitions” line above consists mainly of Dell’s “support and deployment” activities.  This business has less correlation with the PC business and more closely follows the expansion of data center activity.   In the last quarter, a quarter in which PC revenue declined by 19%, this support and deployment business grew by 5%. Estimates of its revenues are approximately $4.8 billion, at which we believe it would produce at least $1.0 billion of operating income.   This operating income should be assigned a higher multiple than that attributed to the PC business. Our estimate of its value is at least $7.0 billion, or $3.89 per share.
• The PC business generates roughly $27.0 billion of revenue and we estimate approximately $1.3 billion of operating profit.  While we could accept the most bearish case in assuming the “death of the PC,” this business is certainly worth more than zero.  Even the PC’s harshest critics would accept that the PC will be around for more than a few years.  A multiple of operating income of 4 gives this business a value of approximately $5.0 billion, or $2.78 per share.  We would note that Lenovo (primarily a PC company), with net income of around $700 million, has a market value of $11.0 billion. 
• The Software and Peripherals segment not captured above should be worth at least $3.0 billion, or $1.67 per share, which works out to a multiple of less than 7 times operating income.
• We subtract $1.00 per share to account for capitalized unallocated expenses.