Dell: How to Play This Deal

A possible arbitrage opportunity for public market investors

Alex Dumortier
Alex Dumortier, CFA
Mar 26, 2013 at 7:00PM

The summit is only a few steps away! Investors shook off concerns about contagion from Cyprus today, handing the S&P 500 (SNPINDEX:^GSPC) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES:^DJI) a very respectable 0.8% gain. For the S&P 500, this is the 11th time this month the index has closed within 1% of its October 2007 high; surely that "ceiling" can't resist much longer.

Consistent with those gains, option traders pushed the VIX (VOLATILITYINDICES:^VIX), Wall Street's "fear index," down 7% to close at 12.77. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

Breaking the deal process down
Two new bidders joined the fray in the battle to take PC maker Dell (UNKNOWN:DELL.DL) private (or semi-private) over the weekend, and they're no greenhorns: private-equity giant Blackstone and legendary activist investor Carl Icahn. Let's be clear from the outset: Neither is a defender of shareholders, per se -- they operate with a very narrow yet highly developed sense of self-interest. However, in doing so with regard to Dell, they appear to be creating an attractive arbitrage for public market investors. Here's where we stand:

  • In February, Dell agreed to be acquired by Silver Lake Partners and Michael Dell for $13.65 per share. As part of the transaction, Dell's board opened the process up to competing bidders during a "go-shop" period.
  • Blackstone has offered at least $14.25 for the whole company; it's amenable to having founder Michael Dell and major shareholders roll their stakes over into the acquired company.
  • Meanwhile, Icahn is offering $15 for 58% of the company, which would leave an "equity stub" still trading.

A specially appointed committee of Dell's board will now evaluate the two new offers, and they may invite one of the parties to make a formal bid. Silver Lake Partners would then have one opportunity to make a counterbid.

How should investors evaluate this situation? Let's start with a reference price equal to today's closing share price of $14.50 and think through some of the possible scenarios:

  • The board awards the company to Blackstone, and Silver Lake declines to raise its offer. Investors face a 2% loss (they receive $14.25 for shares now valued at $14.50).
  • The board awards the deal to Icahn, and Silver Lake declines to raise its offer. Investors who tender their shares to Icahn earn a 3% return; those who keep their shares face greater uncertainty, but they have Icahn working for them to raise the share price.
  • Silver Lake Partners wins the contest. Given the opposition of major investors to their initial offer and the presence of competing offers, it's unlikely that they will walk away with the prize without a sweetened offer that's higher than Blackstone's. (We're comparing like-for-like deals; Icahn's offer is different.)
  • The deal collapses entirely -- all bidders ultimately walk away. In this situation, who knows what would happen to the share price, but the interest a Dell sale has generated suggests the shares are undervalued at current prices.

In this analysis, the worst-case scenario -- the first one, which I consider relatively unlikely -- has investors losing 2%. In all other scenarios, they earn a positive return or are left with shares that are quite likely undervalued. Small consolation for longtime shareholders, perhaps, but it may leave new investors with an arbitrage opportunity.

Editor's note: A previous version of this article incorrectly described the bidding process. The Fool regrets the error.