Sifting Through Dell + VMware Rumors and Reinvention

What is Happening?

Less than five years after Dell Technologies’ own and at-times contentious privatization effort, we’ve begun hearing rumors that the company might pursue a reverse-merger with VMware Inc., in large part to resolve EBITDA woes. Dell currently owns more than 80% of outstanding VMware shares, mostly through its 2016 acquisition of VMware parent firm EMC.

In a week already filled with real and rumored M&A activity, a few of which are unconventional (e.g., the Birlasoft-KPIT merger-to-split announced 30 January), this one stands out as potentially one of the more complex – and one that, if it occurs, would have the most significant impact on company re-invention.

Why is it Happening?

Less than five years after a widely-publicized and challenging fight to bring Dell private, why would company leadership be interested in, let alone pursue, a deal that would in effect return it to public scrutiny and regulation?

A reverse merger with VMware would allow privately-held Dell to return to being traded publicly, without going through an unpredictable IPO. After substantial reorganization, restructuring, sell-offs, and partner re-alignments, Dell would retain significant resources - but could have access to even more through public securities markets. Filing for an IPO itself would return Dell to former levels of scrutiny and shareholder interference/participation, something that Chairman Michael Dell let be known was a primary motivation to take the company private in 2013.

This unusual strategy would also help Dell manage its substantial debt load, more than $8B of which matures in or before 2020. Even after its late-2016 selloff of Dell Services to NTT Data Inc. for $3B; and Dell Software to private equity firm Francisco Partners Management LLC and activist hedge fund Elliott Management Corp. for $2.4B; and selling the Enterprise Content Division to OpenText Corp. last month, Dell reported almost $53B in debt as of the close of 3Q2017. Bonus: Being “acquired” by VMware would enable Dell to take advantage of VMware’s nearly $3B in free cash flow along with $7.6B in cash (net of debt).

We have seen suggestions from Wall Street that Dell may be experiencing urgency to reduce debt and interest in response to the recent passage of the U.S. Tax Cuts and Jobs Act. The Act limits annual interest expense deduction to 30% of EBITDA; Dell's interest expense has averaged between 40% and 55% of EBITDA over the past two fiscal years, according to reports.

Impact

On the one hand, we are speculating. At this writing, there has been no official word from Dell on this subject, nor has there been any reputable reports (or leaks) confirming or denying the rumors. On the other hand, it is fairly simple to rationalize this solution for Dell. It makes sense if it happens. And there is enough deal-implied smoke being sensed by Wall Street to suggest some real fire in the board room.

In our view, a reverse merger with VMware is just one of several strategic options under consideration by Dell. While the company’s debt burden is significant, and the company continues to re-invent itself in a rapidly-changing enterprise IT environment, we know of no overbearing/immediate factors forcing such a deal to take place. The rewards could be substantial, as noted above. But as far as we can determine, Dell has not decided on this as the path forward. Company leadership is known to be considering several possible options, including acquisitions, taking Dell public through an IPO, or buying the shares of VMware that it does not own – effectively taking VMware itself private. We, along with the rest of the marketplace, look forward to reports from Dell’s scheduled board of directors meeting later this month.

Regardless of which option Dell pursues to boost revenue and restructure debt, we remain fairly bullish on the future of VMware, and do not expect Dell to divest itself of the same. While the enterprise market for VMware’s primary virtualization technologies and offerings have declined, the order-of-magnitude growth patterns in the use of cloud, hybrid cloud, and converged cloud services suggests massive and growing opportunity for VMware and its offerings, assuming effective management and investment.