Dell deal unlikely to open LBO mega-buyout door

April 2013 | FEATURE | PRIVATE EQUITY

Financier Worldwide Magazine

The early months of 2013 have undoubtedly seen the M&A market pick up, with a spate of deals across a number of different sectors bringing confidence back to the markets. Part of this uptick has seen the leveraged buyout (LBO) become a hot topic once again. The 5 February announcement that Dell Inc. was being taken private by its own founder, Michael Dell, in a $24.4bn leveraged deal, prompted analysts to speculate on the wider implications of the transaction for the private equity industry.

For some, the return of LBOs means that the mega buyout is now back on the agenda. Last seen in the less turbulent days of the mid 2000s, mega-buyouts disappeared from view when the credit bubble burst in mid-2007. Conditions for LBOs have improved recently, however. Interest rates have fallen steadily, resulting in considerably looser debt markets. Accordingly, many private equity firms are now looking to take advantage of the current low interest rates and the huge volume of available cheap debt.

Return of the megadeal?

Rumours of the Dell deal had been circulating for a number of weeks and, when the agreement was finally announced, it was confirmed that four banks had committed nearly $14bn in debt to facilitate the purchase. The $24.4bn price agreed for the company is one of the biggest LBOs of all time, dwarfing those seen since the onset of the financial crisis. At the height of the buyout boom in 2007, there were five buyouts valued at $20bn or more, yet the largest deal of the recent pre-Dell era saw Kohlberg Kravis Roberts and Co. acquire Samson Investment Co for a comparatively small $7.2bn in 2011.

Although the Dell deal does utilise a large amount of financial engineering, Mr Dell and his partners are relying on less leverage than previous LBOs. With Mr Dell agreeing to contribute over $3.7bn worth of equity to finance the deal, and taking into account the company’s cash reserves of more than $11bn, the deal’s leverage is only 2.5 times debt to earnings interest, tax, depreciation and amortisation (EBITDA). According to data held by S&P Capital IQ Leveraged Commentary & Data, the average leverage multiple for private equity deals in 2012 was 5.3 times EBITDA.

Stephen Schwarzman, chief executive officer of the Blackstone Group LP, told Bloomberg TV that the Dell takeover “isn’t your run-of-the-mill situation. This is a pretty unique set of circumstances with a fundamentally unleveraged company with an owner and founder that can put up a lot of equity to make the deal happen.” Therefore, despite the encouraging signs that private equity fundraising is recovering and cheap debt financing is readily available, Dell’s LBO may prove to be the exception rather than the rule.

Unlike many other buyout candidates the beleaguered PC manufacturer has a founder in Mr Dell who is willing and able to contribute a large amount of his own capital, a considerable stake in the company (14 percent), towards the buyout. Equally, with Microsoft as a partner, Silver Lake only needed to contribute $1.4bn of capital to the total buyout fund. Without the considerable financial outlays of Mr Dell and Microsoft, it is entirely possible that Silver Lake would have had to pursue a much less desirable ‘club deal’ with rival private equity firms in order to raise the required level of funding.

Dell, however, isn’t the only huge company subject to an LBO in early 2013. In February HJ Heinz Company also announced that it had agreed to be acquired by a consortium comprising Warren Buffet’s investment company Berkshire Hathaway and 3G Capital for $23bn. Around $7bn of that total will be financed by debt provided by a number of banks. The remainder of the funding will be provided by Berkshire, 3G and Mr Buffet himself. It would also appear that Mr Buffet does not expect to exit Heinz anytime soon, as one would expect with a regular private equity deal. In a telephone interview with the New York Times Mr Buffet noted that “We may increase our ownership if any members of the 3G Group ultimately want to sell out later.”

It is clear that the LBO deals we are beginning to see in 2013 are markedly different from those which have come before.

Private equity reawakens

Seemingly, 2012 was the year in which the private equity world reawakened, and investors showed signs of being attracted once again to bigger buyout funds. In 2012 the Carlyle Group committed to raising a $10bn buyout fund. Silver Lake launched its latest fund, Silver Lake Partners IV, with a target of $7.5bn in committed capital. November 2012 saw Advent International Corp reach a close on its $10.8bn buyout fund – the largest such fund since Blackstone’s $21.7bn fund of 2007. Inflows into debt funds also continued to grow throughout 2012, as did the market for collateralised loan obligations, with inflows of $55bn, all of which needs to be invested.

Data from Private Equity International suggests that buyout funds were the most popular private equity funds with institutional investors in 2012, raising $130.9bn worldwide – an increase of 49 percent year on year versus 2011. Moreover, in November 2012, Bank of America noted that existing market conditions had become “unusually conductive for leveraging transactions”.

Despite others in the industry remaining sceptical about the future of LBOs, mutual fund company and independent investment research firm MorningStar is confident that the Dell LBO will open the door for similar deals in the near future. “We believe banks have an increased appetite for funding LBOs, as they have repaired their balance sheets and need to expand net interest margins (which have been contracting). The high-yield market is wide open to new issuers and debt is cheap with all-in-yields near all time-lows. Additionally, private equity firms need to put money to work before capital commitment periods start to expire. With a strong market rally in the back half of 2012, we believe relative valuations have recovered enough that boards won’t feel like they are selling too low, but still offer attractive internal rates of return to potential private equity sponsors”, said the firm.

However, others believe we are unlikely to see blockbuster leveraged deals on the scale of the mid-2000s, any time soon.

Pitchbook Data Inc. suggests that although the average fund size has now returned to a level comparable with 2007 and 2008, only five new $5bn-plus funds raised have been seen in the last three years. In 2007 and 2008, 11 such funds were raised in each year alone.

Furthermore, private equity firms are demonstrating far more caution in the post-financial crisis world. As a timely reminder of the perils of huge leveraged deals, on 19 February, US power company Energy Future Holdings, formerly TXU Corp, warned that it may well go into bankruptcy, liquidation or insolvency if its lenders or noteholders choose to accelerate the repayment of its borrowings. TXU was taken private in 2007 for $45bn. The deal for the company burdened it with a cripplingly large amount of debt ($16.5bn) and is regarded as one of the most spectacular failures of the buyout boom of the mid-2000s.

Firms are also less likely to find suitably large targets for acquisition after a rally in the stock market this year. That is not to say that such opportunities have disappeared entirely. Stephen Pagliuca, managing director at Bain Capital LLC, noted at the SuperInvestor conference in February that “You have to be disciplined. If you buy a large company it has to be a special opportunity and there are such opportunities out there. There are conglomerates that have been badly managed for years and you can unlock a lot of value by buying these companies.”

Dell deal not yet done

At the time of writing it is not certain that the privatisation of Dell will actually be completed. In mid-February the company released its first quarterly earnings report since the deal was announced, and what could turn out to be its final earnings reports after nearly 25 years as a public company. The company reported marginally better quarterly results than Wall Street had anticipated. However, the figures demonstrated the size of the challenge Mr Dell and partners face should the deal go ahead. Net income dropped 31 percent in the last quarter of 2012 to $530m from $764m in the same period of the previous year. Dell also reported that revenue fell 11 percent to $14.3bn in 2012. Revenue from the company’s networking business climbed 42 percent however, while server revenue also rose 5 percent.

These stronger than anticipated financial results, however, play into the hands of a number of already disgruntled Dell shareholders who feel that Mr Dell’s buyout offer materially undervalues the the company. Southeastern Asset Management (SAM), Dell’s largest outside shareholder with an 8.5 percent stake in the company, argued that the $13.65 per share offer “grossly undervalues” the firm and that it would avail itself of all options to combat the deal. Dell’s third-largest shareholder, T. Rowe Price Group Inc., shared SAM’s view of the deal. In a statement, chairman Brian Rogers said “We believe the proposed buyout does not reflect the value of Dell and we do not intend to support the offer as put forward”.

While we may not see a mega-buyout boom in the immediate future, private equity dealmakers are beginning to dip into the vast sums of available capital that has been raised but not invested in the last few years. PitchBook currently estimates a total overhang of $348.2bn, with more than $100bn of dry powder remaining in funds raised in 2007 and 2008. It is likely that, should any potential megadeals arise, banks will also demand a significant equity contribution to the LBO capital structure.

If the deal to take Dell private does win the approval of the company’s shareholders, due to the size and makeup of the transaction, it will be a watershed moment in the post-financial crisis economy. Mr Dell and his partners will have completed a historically significant LBO that, while not opening the floodgates for highly leveraged acquisitions to once again dominate the M&A market, would potentially represent a strong jumping-off point for future deals.

Richard Summerfield