Silver Lake Breakup Rules Make Ending Dell Bid Costly

By Peter Burrows & Jeffrey McCracken

Silver Lake Management LLC and Michael Dell attached such stringent conditions to their Dell Inc. (DELL) buyout proposal that they may have little choice but to stick with the deal even as the personal-computer industry contracts at a faster-than-predicted pace.

Walking away from the $24.4 billion leveraged buyout means the Silver Lake-led group would have to pay as much as $750 million to extricate itself, according to the merger agreement. The terms also let Dell sue the group to force it to complete the transaction. Dell’s stock fell below the original $13.65-a-share offer on April 19 amid speculation that the deal might unravel afterBlackstone Group LP (BX) abandoned its counteroffer, citing “the rapidly eroding financial profile of Dell” and greater weakness in the PC market than the company is projecting. Still, the Silver Lake-led group will probably stick with its plan, rather than subject itself to financial penalties, said Erik Gordon, a professor at the Ross School of Business at the University of Michigan in Ann Arbor.

“Silver Lake is in a corner,” Gordon said. The provision allowing the company to sue is “a gun to Silver Lake’s head. If it wants to back out, it will have to negotiate a settlement that makes the company happy or close the deal,” he said.

When CEO Dell and Silver Lake began buyout discussions last year, the PC maker predicted operating income of $5.6 billion for the fiscal year through January 2014, according to a March 29 filing. That forecast was reduced to $3 billion after three revisions and a record drop in PC shipments during the first quarter.

Deal Terms

Neither Silver Lake nor the banks financing the buyout -- Barclays Plc, Bank of America Corp., Royal Bank of Canada and Credit Suisse Group AG -- have expressed a desire to get out of the deal after Blackstone pulled out April 19, said a person with knowledge of the matter who declined to be identified because the information is private.

Steve Lipin, an outside spokesman working for Menlo Park, California-based Silver Lake, declined to comment, as did David Frink, a spokesman for Dell. Dell said in a filing April 19 that it continued to support the agreement with Silver Lake and expected the deal to close by the end of the fiscal second quarter, which ends in July.

Chief Executive Officer Michael Dell and Silver Lake agreed to therestrictions, which also included limits on their ability to match bids for Dell, in order to create a deal that would withstand shareholder scrutiny, people familiar with the matter said after the agreement was announced Feb. 5. The breakup fee is also higher than normal, said the people, who asked not to be identified because the talks were private.

Silver Lake

Under the terms, the Silver Lake-led group agreed to pay the company $250 million if it withdraws the offer because of changes in tax law, or if other legal obstacles emerge. The higher $750 million penalty applies if the group simply backs out, breaching the agreement.

Unforeseeable developments that would be considered a “material adverse effect,” such as representations turning out not to be true, could also let Silver Lake and CEO Dell pull out of the agreement with fewer or no penalties. Any dispute taken to court would probably result in a deal, according to Barbara Black, a law professor at Columbia University in New York.

“A court could order Silver Lake to complete the deal rather than just forcing the private-equity fund to pay Dell damages,” Black said in an interview.

Silver Lake came close to walking away in January, during a stalemate that wasn’t resolved until it increased its final offer by 5 cents a share.

PC Slump

“If Silver Lake closes the deal, it has time to address its problems if the deal turns out to be a bad deal,” Gordon said. “If Silver Lake balks, it has a problem, today, and probably kisses a couple of hundred million dollars goodbye.”

Research firm IDC released data earlier this month showing that PC shipments plummeted 14 percent in the first quarter, a faster pace than its projection for a 7.7 percent decline, as demand dropped in every region of the world. The slump comes as consumers shun PCs in favor of smartphones and tablets to check e-mail, browse the Web and watch television and movies.

Blackstone had offered to pay at least $14.25 a share to current Dell investors with an option to hold onto some of their stake through a so-called equity stub.

Logical Investor

Blackstone pulled its offer after deciding that Dell’s plan to expand share in the $3 trillion enterprise-computing market was still years away, a person familiar with the matter said last week. Profits from new products weren’t going to be generated fast enough as the PC business deteriorated, said one of the people, who declined to be identified because the details were private.

“The PC problem is just the start of it,” said Tripatinder Chowdhry, an analyst at Global Equities Research in San Francisco. “Enterprise servers are going to get hit, too.”

Shares of Round Rock, Texas-based Dell fell less than 1 percent to $13.35 at 9:44 a.m. in New York, 2.2 percent less than the original deal price.

Before Blackstone dropped its bid, the stock had been trading at a premium to the offer on speculation that a bidding war would erupt after Blackstone and billionaire investor Carl Icahnproposed higher offers. Dell’s largest outside shareholders including Southeastern Asset Management and T. Rowe Price Group Inc. also opposed the original bid as being too low.

“Blackstone was viewed as a more logical investor to follow through with this deal, so with them gone, the prospect of a bidding war is also gone,” said Rich Kugele, an analyst at Needham & Co. in Boston who has a hold rating on the shares.

Icahn’s Proposal

Blackstone’s exit also followed reports that International Business Machines Corp. (IBM) is in talks to sell its low-end server division to Lenovo Group Ltd. (992) Servers have been a bright spot for Dell, posting 18 percent sales growth in the latest quarter.

Dave Johnson, one of the Blackstone executives overseeing the firm’s bid, joined the buyout group in January from Dell, where he led mergers and acquisitions for almost four years. Before that, he served in a similar role at IBM, making him uniquely qualified to assess the risks and rewards involved in a proposal to buy the PC maker.

Even if Silver Lake remains committed, Michael Dell and the private-equity firm will have to deflect a rival proposal by Icahn, who has offered to pay $15 a share in cash for as much as 58 percent of Dell’s stock. The company has said that Icahn’s proposed offer could be superior to the Silver Lake group’s deal for all of the company.

Proxy Fight

Dell said April 16 that Icahn had agreed not to amass more than a 10 percent stake in the company, or to join with other shareholders to build more than a 15 percent holding.

Icahn said he’s retaining the right to start a proxy fight and seek to replace Dell’s directors with his own candidates. That’s not likely to happen until after a vote by shareholders at an annual meeting, which hasn’t yet been scheduled yet. A majority shareholder vote in favor of the deal, excluding Michael Dell’s 15.6 percent stake, is required for approval of the joint offer with Silver Lake, according to the agreement.

To contact the reporters on this story: Peter Burrows in San Francisco atpburrows@bloomberg.net; Jeffrey McCracken in New York at jmccracken3@bloomberg.net

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