Inside the Dell buyout

Dell Computer has fallen on hard times recently. The stock lost 43 percent of its value in the past five years. It hasn’t been able to compete with Apple and Samsung in the tablet and phone markets, nor with Oracle and Cisco in the data-center space, and the core of Dell’s business, the PC market, has been shrinking.

But founder Michael Dell, who started his namesake company out of his dorm room at the University of Texas at Austin in 1984, had one more trick up his sleeve. If investors had lost interest in buying his stock, he would make them unable to buy his stock, by taking the company private. And that may be the best possible thing he could have done for the value of Dell.

Dell the company announced plans for a leveraged buyout earlier this week. The share price shot up by 13 percent in a single day. That might be only the beginning, though. By the time the LBO is completed— which may have happened by the time you read this – the premium accruing to Dell’s shares could be as high as 30 percent or more.

That’s not an uncommon pop for stocks that try to go private. Two economists at Oxford University in Great Britain looked at all the companies that went private through an LBO from 2003 to 2008. They found a weighted average premium for shareholders of 26.2 percent compared to the pre-takeover stock market value of these companies. In raw terms, the overall market capitalization of the bought-out companies prior to the takeover announcement was about $413 billion and shareholders received immediate capital gains of $108 billion when those companies went private.

The premium that the shareholders receive fluctuates as a result of a variety of factors, most of them having to do with the company’s balance sheet. The amount of debt the company is carrying would be subtracted from the selling price; the amount of cash on hand gets added. Taking the market capitalization and adding the debt then subtracting the cash produces what’s known as an enterprise value, which for Dell is around $19 billion. The LBO premium is added on top of that enterprise value.

That’s why it’s hard to tell, strictly from looking at the share price, what kind of pop will result from going private. The Oxford researchers found that a 25 percent premium on a company’s equity premium can translate into an enterprise value premium of anywhere from 12 percent to 31 percent.

And there’s evidence that the number is sitting at the high end of the range in current times. The news service Thomson Reuters found that last year the average takeover premium for all leveraged buyouts was 30 percent. Among the high-tech sector, where Dell resides, the figure was slightly higher than that.

The problem for these LBOs is getting them to come to fruition after all the announcements have been made. Especially in the high-tech arena, the stories have had a paucity of happy endings. In 2000, the disk-drive manufacturer Seagate Technology was taken private by an investment group that also bought Veritas software at the same time and merged it with Seagate. But less than two years later, a frustrated Seagate went public again. As Seagate CEO Bill Watkins told Money magazine in 2006, “When you go private, the only thing you think about is going public again.”