Market Integrity Insights 07 Feb 2013
Dell Goes Private: Saving Company from Market Short-Termism or Smart Tax Strategy?
By now you have probably heard that Dell founder Michael Dell is looking to take his eponymously named company private with the help of private equity firm Silver Lake Partners. The size of the deal, at $24.4 billion, has caught the imagination of the financial media as it would represent the largest private equity buyout since the financial crisis.
The debate in the media has mainly focused on the perceived inability of a company to perform the kind of turnaround Dell is looking to do in the public market with the short-term quarterly pressures that come with being a public company. This assumes that public shareowners are not capable of a long-term view and seeing the benefits of the type of reorganization Dell is attempting.
We have frequently written on the issue of market short-termism, most recently in our Visionary Board Leadership paper, which calls on corporate directors to combat the market short-termism that is reportedly behind Dell’s move (among other things) by stepping away from the quarterly earnings guidance game and fostering better communications with investors around long-term company strategy.
I’m sure Dell investors have been grumbling in recent years, as the company share price has fallen more than 70% since its high in 2000 and is down about 50% over the past five years. But according to the company’s most recent proxy filing, Michael Dell owns about 14% of the company’s shares, making him the company’s largest shareholder by far. Add to that the fact that the majority of the company’s shares are held by large institutions and I would ask the simple question:
Has Dell Inc. adequately communicated the company’s long-term turnaround strategy to its shareowners?
Because if I were a Dell shareowner (I’m not directly, but I’m sure I own its shares in the index funds I own in my retirement account), this is the question I would have pondered the last five years.
The answer may in fact be “no.” I found it telling that, according to a front page Financial Times article on 6 February, “… no member of Mr. Dell’s consortium offered details of the strategy, or specifics on how being private would benefit the company.”
Private equity is often brought in to kick out a management team that has grown long in the tooth, or doesn’t have the vision or the will to do what is necessary to turn around the company. The argument in favor of private equity often emphasizes that private equity investors will exercise more disciplined oversight than is possible with the management of a publicly traded company. But Michael Dell is leading the charge to go private, even providing a large chunk of the payout to shareholders. So what is going on here?
I know the short-term pressures of the market are real. In our discussions on the topic of short-termism with companies, directors, investors, and analysts we hear again and again of the short-term focus of the markets. But I’m cynical by nature, so I went looking for other answers.
I came upon an article by Matthew Yglesias, business and economics correspondent at Slate, who argued that part of the reasoning behind the deal is one as old as the hills: tax avoidance. Yglesias writes:
Dell’s cash stockpile and current profits ought to make it a valuable company despite its poor growth outlook. But before those profits or cash holdings can be paid out to shareholders as dividends, they would have to be “repatriated” to the United States. Then a 35 percent corporate income tax would be levied, and only then would shareholders get their money.
A leverage buyout offers a workaround to avoid many of these taxes. Shareholders make money directly as their shares are bought back at a premium. Much of the money that would go to buy the shares would be borrowed from banks, who’ll earn a profit of interest payments. Those interest payments can be made, in part, with the repatriated cash. Except this time the cash would not be taxed, since interest payments on corporate debt are a tax-deductible expense. Like magic, Dell’s shareholders would be extracting money from the firm without giving Uncle Sam nearly as big a cut.
I doubt that the tax question is the only one driving this deal, but I’m sure it is a motivating factor. The United States has the second-highest corporate tax rate in the world, and is one of the few countries that taxes the earnings of a company from its overseas operations. As a result, tax becomes a competitive issue as well. Also note that this deal is happening while tax reform talks in Washington are percolating and could potentially change the attractiveness of leveraged buyouts in the future.
According to terms of the deal currently available, Silver Lake and Michael Dell are borrowing about $17 billion of the $24 billion Dell purchase price, which means they are providing about $7 billion of equity capital in the deal. Some current Dell investors have voiced displeasure that they will not get use of the cash currently sitting on the company’s balance sheet, and that Silver Lake and Dell will likely pay themselves a dividend out of this cash pile in order to cover their cash investment.
The deal has to be approved by a majority of shares outstanding, excluding shares owned by Dell management and directors. It will therefore be interesting to see if the majority of investors who can vote on the deal are patient enough to wait for the transformation of Dell to be complete, or if they take the money and run. Again, I’m cynical, so I would bet on the latter. I would be surprised if investors voted “no” on the deal, arguing that they want to benefit from the Dell turnaround instead of letting private equity investors do so.
It seems to me a few different things could be happening here: the long-term strategy may not have been adequately communicated to shareowners; management isn’t patient enough with its own turnaround and wants to take advantage of the tax advantages of a buyout and historically low interest rates. And finally, investors don’t want to defer gratification for an unsure payoff down the road if they can get something now. Probably all three.
About the Author(s)
Matt Orsagh, CFA, CIPM, is a director of capital markets policy at CFA Institute, where he focuses on corporate governance issues. He was named one of the 2008 “Rising Stars of Corporate Governance” by the Millstein Center for Corporate Governance and Performance at the Yale School of Management.