Deal Overview

As per media reports on June 23, Dell Technologies Inc

DELL
. (NYSE: DELL, $52.25, Market Capitalization: $38.7 billion), a leading global end-to-end technology provider, is considering a spin-off of its majority stake in VMware

VMW
Inc to its shareholders.
Dell, which owns 80.6% of VMware, is evaluating options of either spinning off the holding to existing Dell shareholders or buying the remaining stake in the group that it doesn’t already own and then spinning off the entire stake. However, the exact structure of a spin-off of the VMware stake is not clear, and the report described Dell’s evaluation process as being in the early stages, with working groups formed only recently to examine the options around the VMware stake. Dell is also assessing various implications of such a move, from corporate governance/capital structure perspective and how the companies could work together following a separation. Dell Technologies’ stock price soared 18 percent, to $57.80 a share, in after-market trading on Tuesday, June 23, while VMware’s stock price jumped 9 percent to $162.80 a share. Subsequently euphoria has abated and stock prices of both companies have cooled off.

Dell went private in a 2013 leveraged buyout by Mr Dell and private-equity firm Silver Lake. In 2016, Dell acquired its stake in VMware through the $67 billion buyout of EMC Corp. As part of this transaction, the Company created a tracking stock to mirror the value of VMware, an independent and publicly-traded company. However, it was not very successful and the tracking stock lagged substantially behind the price of VMware shares. Meanwhile, Dell’s massive debt load and complicated capital structure made a traditional IPO process difficult when founder Michael Dell and private-equity firm Silver Lake wanted to reintroduce the Company to the public markets. So in 2018, Dell decided to simplify the structure by buying out the tracking stock. A protracted battle ensued with shareholders of the tracking stock, including P. Schoenfeld Asset Management and Carl Icahn; however, the deal was completed.

Deal Rationale

Dell’s shareholders have witnessed a series of financial engineering transactions in the last seven years, without adding much shareholder value. The Company’s intention to explore strategic alternatives could be a result of poor relative stock performance since going public through a complicated process in December 2018. To the frustration of Dell investors, since returning to the public markets in 2018, Dell has under performed the tech-heavy Nasdaq Composite Index by ~33%. The strategic review aims at addressing the valuation gap between Dell’s implied Enterprise value of ~$88 billion and the value of its 80.6% stake in VMware of approximately ~$50 billion, which implies that the market is undervaluing Dell’s core business. Potentially, a spin off would confer more direct ownership of the VMware business to shareholders than the tracking stock previously did, thereby reducing the valuation discount. Furthermore, the spin-off is likely to unlock value for its shareholders as the market would assign the full value of VMware’s stake and its desktop and data storage business. Also, the spin-off would bolster VMware’s valuation by erasing the ‘ownership discount’. The market believes that Dell has a substantial value which is not currently reflected in its share price. The stock’s valuation is weighed down by multiple factors including its high net leverage, conglomerate discount, limited voting rights and concentrated ownership structure. Despite the positive consequences, the spin-off is unlikely before next year as Dell cannot effect a tax-free spin of its VMware stake until September 2021, due to a rule requiring both companies involved to have operated continuously for five years to qualify for such treatment.

As a part of the EMC merger, Dell had taken a large debt, and at the end of FY20, the Company reported $48.4 billion in long term debt. As the Dell has significant debt on its balance sheet, the Company is planning to reduce core debt by ~$5.5 billion this fiscal year and use the proceeds from first quarter bond issuance to refinance additional $2.25 billion this year. There is a possibility that Dell could do partial disposal of its VMware stake, which could speed up the pace of deleveraging on its path to attain investment grade rating within the next 18-24 months. Dell’s buying out of remaining stake in VMware looks unlikely considering Dell’s current debt position.

Company Description

Dell Technologies Inc. (Parent)

Founded by Michael Dell in 1984, Dell Technologies is a leading global end-to-end technology provider, with a comprehensive portfolio of IT hardware, software and services solutions spanning both traditional infrastructure and emerging, multi-cloud technologies that enable users to build their digital future and transform how they work and live. The Company operates globally across vital functional areas such as technology, product development, marketing, go-to-market & global services; supported by Dell Financial Services. The Company continues to seamlessly deliver differentiated and holistic IT solutions to the users, which has driven significant revenue growth and share gains. The Company’s business segments include Infrastructure Solutions Group, Client Solutions Group, and VMware. As of May 1, 2020, Dell held 80.6% of VMware’s outstanding common stock and 97.4% voting power of VMware’s common stock. Infrastructure Solutions Group enables the digital transformation of the customers through multi-cloud and big data solutions, which are built upon a modern data center infrastructure. Client Solutions Group includes branded hardware (such as desktops, workstations, and notebooks) and branded peripherals (such as displays and projectors), as well as third-party software and peripherals. The VMware segment reflects the operations of VMware, Inc. within Dell Technologies. In FY20, Dell Technologies generated revenues of $92.2 billion.

VMware Inc. (Spin-Off)

VMware works with clients in the areas of hybrid & multi-cloud, modern applications, networking, security, and digital workspaces, helping clients manage their IT resources across private clouds and complex multi-cloud, multi-device environments. VMware helps clients manage their IT resources across private clouds and complex multi-cloud, multi-device environments by offering solutions across three categories: Software-Defined Data Center (SDDC), Hybrid & Multi-Cloud Computing, and Digital Workspace-End-User Computing (EUC). SDDC architecture consists of 4 main product categories – Compute, Cloud Management, Networking, and Storage & Availability. VMware’s Multi- Cloud offering is based on consistent infrastructure and operations across the data center, public cloud and edge environments. This allows clients to benefit from a single deployment model with consistent security policies, visibility and governance for all applications, running on-premises and off-premises. VMware’s EUC portfolio offers a digital workspace to enable customers to more securely deliver access to applications and data for the end-users from any device of the user’s choice and any location. VMware, Inc recorded revenues of $10.8 billion, and non-GAAP net income was $2.66 billion in FY20.



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