Carl Icahn (Trades, Portfolio) wrote an open letter to fellow Dell DVMT shareholders Monday saying he does not like the proposed merger with VMWare. Icahn holds 8.3% of its tracking shares.
This is a very complicated situation. I’ll quote from Icahn’s letter liberally but change the order of quotes around and leave sentences out when I think these serve little purpose besides Icahn wanting to “frame” the issue a certain way.
"Several years ago, I believe Dell and Silver Lake realized that Dell Technologies was facing great secular challenges … Therefore, they levered up dramatically to purchase EMC Corporation ('EMC'), a better positioned hybrid hardware and software company, whose crown jewel was its 82% ownership interest in VMware, Inc."
This ultimately happened and is a reasonable assumption to make.
"But, to purchase EMC, Dell needed $10 billion more than its bankers could possibly arrange, and they also needed to convince EMC stockholders that Dell’s offer was worth accepting. They accomplished this by engineering the DVMT Tracker that they said would allow EMC stockholders to continue to participate in VMware’s upside."
The DVMT tracker stock gives exposure to VMware VMW but not to the rest of the acquiring company. By doing this, Dell didn’t need to buy the entire company since the tracking stock was “left behind, and offering a package of tracking stock and cash may have been more attractive to some shareholders.
But taking stock is always a little bit tricky, especially something as adventurous as tracking stock. A person famous for employing its use is the financial engineering genius John Malone.
"Because a tracking stock is unusual and rarely included as merger consideration, Dell and its bankers had to convince EMC stockholders that the Tracker would efficiently “track” the economic value of VMware shares. To that end, one of Dell’s bankers at the time delivered a fairness opinion that assumed the Tracker would trade at a range of +/- 5% to VMware shares; while another banker assumed the Tracker would not trade at more than a 0-10% discount to VMware shares.[2] Dell sold EMC stockholders the Tracker assuming, at most, no more than a 10% discount, yet today, Dell and some of those same bankers are now soliciting your vote to agree to exchange your DVMT shares at a 36% discount![3]"
By assuming the tracking stock would closely track VMWare shares, the price paid was of course lowered. A key question is whether Dell and its bankers realized this wasn’t a realistic assumption. More about that later.
Icahn then accused Dell management of taking advantage of the trackers' vulnerability to create shareholder value at the Dell level at the expense of value at the DVMT level.The boasts by Dell management, likely about value creation, may really come back to bite them here:
"It seems clear that Dell has long-planned to repurchase the Tracker at bargain basement prices. For two years, Dell management have publicly boasted about Dell’s '…opportunistic opportunities in the market to take advantage of the discount between the two securities'[4] and have repurchased over 23 million DVMT shares at substantial discounts. This plan significantly benefits Michael Dell (Trades, Portfolio) and Silver Lake, but at a huge cost to the DVMT stockholders. Why hasn’t the Dell Board been exercising its fiduciary duties owed to the DVMT stockholders, as opposed to just the controlling stockholders? Make no mistake, if the current 'opportunistic' deal succeeds, 100% of the discount, approximately $11 billion, will be an economic windfall mostly attributable to Michael Dell (Trades, Portfolio) and his Silver Lake partners. It is clear to me that Dell and Silver Lake have followed Machiavelli’s advice to the letter: It is better to be respected than loved, but better still to be feared than respected."
Icahn then attacked Dell's board members:
"I can only conclude the independent directors must have been misinformed by advisors working for Dell and Silver Lake or by Michael Dell (Trades, Portfolio) and Silver Lake themselves. Otherwise, it is unquestionable, in my opinion, that the independent directors breached their fiduciary duties to the DVMT stockholders. How else can one explain an agreement that so obviously transfers $11 billion in value to the controlling stockholders at the expense of the minority stockholders? The one thing these independent directors did get right, however, was to condition the deal on DVMT stockholder approval. I believe the Dell independent directors must take their fiduciary duties to the DVMT stockholders seriously. Any future transactions proposed by the controlling stockholders must always be assumed to be at the expense of the DVMT stockholders and the independent directors must always demand robust protections for the DVMT stockholders. The Board’s fiduciary duty to all stockholders demands nothing less, especially after this fiasco!"
Now this story would be quite simple if it were about Dell being willling to buy the tracking shares just north of $100 and shareholders making noise to get him up to $144 per share. But it would just be a showdown of votes by shareholders. (There is a very good possibility shareholders will not be bought out at the current offer price.)
But there is a questionable trick Dell can employ. If it takes the entire company public, it can force a conversion of the tracking stock into Dell shares. The combined shareholder base would lay claim to the combined value. How that would work out all depends on the value ascribed to each part. But you can guess this would probably not work out well for minority shareholders.
Icahn doesn’t believe in the IPO threat:
"In my view, this is obviously another threat to take advantage of DVMT stockholders who do not understand that an IPO is nearly impossible! Dell, Silver Lake and Goldman Sachs should all absolutely understand that Delaware jurisprudence has developed to protect minority stockholders from coercive controlling stockholders, and I strongly believe, as do my lawyers, that the Delaware courts will protect DVMT stockholders from Dell’s and Silver Lake’s coercive actions. Even if we fail to obtain an injunction, we believe we would have valid claims for substantial damages, which Dell would have to defend under entire fairness, for many years, which is not something either Dell or the Board will want to do. Suffice it to say, we believe it is obvious that the threat of a forced IPO conversion is empty, no matter what they say."
Icahn himself is certainly not afraid of confrontation and is willing to lay down a competing bid:
"... I am considering several options. I believe that if Dell does raise the offer, it will be important to provide liquidity to the DVMT stockholders that want to sell, while also protecting the DVMT stockholders that do not want to sell from being forced out in a merger. In my opinion the best way to balance these competing interests would be to offer a competing partial bid that provides partial liquidity without forcing a merger. As such, I intend to continue evaluating this idea and determine whether other interested parties, including financing sources, may want to participate in, or finance, a transaction of this nature."
A competing bid would put a lot of pressure on Dell to increase the price. Icahn has a history of being satisfied with bids that are increased somewhat and probably doesn’t want the situation to last for years.
But, in the interview he gave to CNBC (below), he did mention that his people are filing a 2020 request for more information from the company. At the moment, it's unclear what the request is exactly but if it brings forward communications at the board level or something similar, it could serve as a catalyst.Ă‚
Disclosure: Author is long DVMT.
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