Bloomberg News

Dell Falls Short of Junk Ignominy in LBO Talk: Corporate Finance

January 16, 2013

Dell Falls Short of Junk Ignominy in LBO Talk

Dell is ranked A2 by Moody’s Investors Service and A- by Standard & Poor’s. Photographer: David Paul Morris/Bloomberg

The bond market is signaling its skepticism that Dell Inc. (DELL:US) will pull off the largest leveraged buyout since 2007 as investors refrain from pushing yields on the personal-computer maker’s debt to speculative-grade levels.

Even as the extra yield investors demand to hold Dell’s $400 million of 4.625 percent notes due April 2021 rather than government securities surged to 309.9 basis points yesterday following reports it was in buyout talks with private-equity firms, spreads are still below the 336 basis-point average for top-rated junk debt with similar maturities, according to Bank of America Merrill Lynch index data.

While borrowing costs have never been lower, bondholders have joined firms from Barclays Plc to Morningstar Inc. in doubting the likelihood of a buyout, in which more debt may be layered on a company that’s struggling to confront weak computer demand. Losing the ability to use its publicly traded shares (DELL:US) to finance acquisitions would also hinder Round Rock, Texas-based Dell’s effort to expand its other businesses, according to bond- research firm CreditSights Inc.

“If you levered pretty high up and lost equity as a potential currency, and if you believe you still need to buy more companies to make that change, an LBO is not necessarily the best thing,” said Ping Zhao, an analyst at New York-based CreditSights. “It does limit their options,” said Zhao, who estimates less than 50 percent odds the buyout goes through.

Bonds Plunge

Dell bonds, which have plunged since Bloomberg News first reported the buyout discussions with private-equity firms, still pay less relative to Treasuries than BB rated corporate debt. Dell, which Zhao said will “almost certainly” drop to high yield if the LBO goes through, is ranked A2 by Moody’s Investors Service and A- by Standard & Poor’s.

Its $498 million of 5.65 percent debt maturing April 2018 had a relative yield of 319.9 basis points, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s lower than the 340 basis points on BB bonds, the highest junk tier, due in three-to-five years, Bank of America Merrill Lynch index data show.

David Frink, a spokesman for Dell, declined to comment on the deal speculation and bond trading.

Dell’s bonds (DELL:US) are trading at levels that imply a Baa3 rating, the lowest investment grade, according to Moody’s Corp.’s capital markets research group. The debt implied an A3 rating last week.

Enterprise Value

Assuming Dell’s stock fetches 30 percent more than its closing price of $10.88 on Jan. 11 -- the average premium on technology LBOs in the past three years -- the enterprise value, or stock-market capitalization plus debt, minus cash, would climb to about $22 billion. The company has $9 billion of total debt, Bloomberg data show.

The last buyout to exceed that amount was Blackstone Group LP’s acquisition of Hilton Worldwide Inc., announced in July 2007 and valued at $26.2 billion, according to data compiled by Bloomberg.

“The question is size,” said Andrew Feltus, who oversees $10 billion in global high-yield debt at Pioneer Investment Management Inc. “The deal size is a little big, about twice as big as the market thought could get done. If they could get to market fast, they might be able to pull it off, but it would definitely push the envelope,” he said.

‘Decent Leverage’

An LBO of that size may push Dell’s debt load to three times earnings, according to a Bank of America Corp. estimate that assumes a 40 percent equity contribution, analysts led by Hans Mikkelsen said in a Jan. 14 report. That’s an increase from 2.09 as of Nov. 2 and would make Dell the most leveraged U.S. computer-hardware company, Bloomberg data show.

With a heavy reliance on the PC market, a need to pursue acquisitions to diversify the business and “a balance sheet that already includes a decent chunk of leverage, we don’t believe Dell is a strong candidate for a leveraged buyout,” Michael Hodel, an analyst at Chicago-based Morningstar, wrote yesterday in a report.

The equity portion of a potential deal could drop to 25 percent with unprecedented low yields on speculative-grade securities making it easier to finance a bulk of the purchase with debt, according to Scott Kimball, a money manager at Taplin Canida & Habacht LLC, a BMO Financial Group unit that oversees $7.4 billion.

Record Yields

“A driving force is, you have yield-hungry investors who are willing to take on a company that produces top-line revenue” of more than $50 billion (DELL:US), Kimball said in a telephone interview. “The idea is to use credit markets to your advantage.”

Junk borrowing costs dropped to a record 6.5 percent on Jan. 14, Bank of America Merrill Lynch index data show.

“We are at the stage in the credit cycle where you start to see re-levering transactions,” said Ashish Shah, the head of global credit investment at New York-based AllianceBernstein LP, which oversees $245 billion in fixed-income assets. Demand for high-yield debt “can facilitate much larger transactions,” he Shah.

That hasn’t dissuaded Hale Holden of Barclays from judging an LBO to be a “low-probability event,” according to a Jan. 14 report. Large technology companies require constant mergers and acquisitions to refresh intellectual property, and “if the company goes private, we think it would have limited capacity for further M&A,” Holden said in the report.

Secular Decline

Dell, which Holden estimates will receive about half its 2014 revenue from the PC market, is confronting weak computer demand in a market increasingly pinched by high-end products such as Apple Inc.’s iPad and competition from Asian manufacturers for low-cost machines.

“This is a case of a business that is in secular decline,” said Joel Levington, managing director of corporate credit for Brookfield Investment Management Inc. in New York, which manages $150 billion. “I do not think an LBO is the solution to Dell’s struggles.”

Michael Dell founded his namesake company at the age of 19 in 1984 in his University of Texas dorm room with $1,000. He led it to the top of the industry by cobbling together PCs from off- the-shelf parts and delivering them directly to consumers at a lower cost than rivals, including International Business Machines Corp.

Default Swaps

The company, which said in a December regulatory filing that its “most attractive areas for profitable growth” include data center management and cloud computing, has spent at least $6.7 billion on takeovers since 2009 of companies including Compellent Technologies Inc., Perot Systems Corp. and Quest Software Inc., Bloomberg data show.

Declining PC demand has helped to support a rise in credit- default swaps linked to Dell, which surged 156 basis points after the buyout reports to 359 basis points, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

The contracts, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, have jumped from 107 basis points last February and now cost more than those linked to competitor Hewlett-Packard Co. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

“It’s a tough market to really get comfortable with how they will get their cash going forward,” Lon Erickson, a Santa Fe, New Mexico-based money manager at Thornburg Investment Management Inc. who oversees about $6 billion of taxable fixed- income assets, said in a telephone interview. “I wouldn’t want to lend too much money on that bet right now.”

To contact the reporters on this story: Mary Childs in New York at mchilds5@bloomberg.net; Charles Mead in New York at cmead11@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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