How Far Will Dell Shares Fall if the Buyout Proposal Fails?

If all goes as expected, shareholders of struggling computer company Dell will on Wednesday finally have a chance to vote on the $24.4 billion leveraged buyout proposed by CEO Michael Dell and private equity firm Silver Lake.

Every indication so far makes it look like the vote will be close. Even though a few large shareholders representing about 10 percent changed their votes in the waning hours before the first attempt to hold a vote was delayed, there’s no question that both camps in the battle for control of the company will spend today and Tuesday scratching for every vote they can muster.

So, what happens if the deal fails? Today, analyst Chris Whitmore of Deutsche Bank Securities weighed in with his own view of the possibilities in a research note circulated to clients. And, similar to what I wrote on July 5, he sees a range of not-very-pretty scenarios.

Of immediate concern to Dell shareholders is where its share price may go in the event that the 43 percent plurality sides with activist investor Carl Icahn in his quest to derail the buyout. If shareholders reject the buyout, Whitmore says, Dell shares would likely fall, and probably by a lot: “In such a scenario, we would expect shares of Dell to return to valuation levels that existed prior to the Dell-Silver Lake LBO announcement.”

Whitmore compared its current trading price — which has been buoyed by the $13.65 buyout price that Dell and Silver Lake made when the offer was first announced — to those of other IT companies, including Hewlett-Packard, EMC, IBM, Cisco Systems and Microsoft, among others. He found that, in the days before the first reports of the buyout plan emerged, Dell shares traded at a price-to-earnings discount of 26 percent when compared to that group.

Given where those companies are trading now, Dell’s valuation is, thanks to the buyout offer, trading way above other companies in the comparison group. If it were trading in the same range, Whitmore argues, its share price would be closer to $9 a share, or about 30 percent below the $13 range in which it has been trading in recent weeks.

Aside from a possible crash in the share price, Whitmore sees a lengthy proxy fight between Icahn and Michael Dell for control of the company’s board of directors. With the CEO freed up from rules that have so far prevented him from voting his 14 percent of shares on the buyout, Icahn and other shareholders in his camp would be unlikely to elect the full slate of directors they want and need to carry out the recapitalization proposal they want to put in place.

“Assuming the deal does not pass next week, we’d expect a proxy fight and reshuffling of the Dell board to ensue. We think it is fair to assume that neither Dell nor Icahn would back down, which will likely result in a proxy fight for control of the board,” Whitmore wrote. If that happens, the most likely result, he said, is a mixed board with some directors loyal to both sides. “It seems a mixed board is the most likely scenario, and with it will come great uncertainty around Dell and its future strategy.”

That would mean a possible halt on the path on which Dell has recently embarked, fighting for share in every market segment. “At a minimum, Dell’s recent decision to strategically focus on market share (vs. profitability) in order to maintain scale would be revisited and it would likely take months for the board to agree on a path forward,” Whitmore wrote.

Worse, directors would reach a stalemate on how to manage cash. “Unless Icahn can gain control of the board, which we view as unlikely given Michael Dell’s ~15 percent ownership, we’d expect Icahn’s leveraged recap plan to meet resistance and would be difficult to implement,” he said.

Who would benefit? Dell’s rivals — chief among them HP — which would use the lack of focus as an opportunity to swoop in and retake some of the market share that Dell has wrestled away in recent quarters. If shareholders approve the buyout, Dell’s aggressive pricing strategy will stay in place and keep pressure on HP and others.

The outcome of the vote will be a watershed moment for both Dell and HP, Whitmore argues, mainly because it appears that demand for PCs among enterprise customers has gone about as high as it’s going to for now. As evidence, he cites recent data from Microsoft showing that about 75 percent of its corporate customer base has upgraded its machines to Windows 7 and off Windows XP. (Most aren’t even close to upgrading to Windows 8 yet.) “As a result, corporate PC demand appears to be peaking and is poised for a material decline in 2014-15,” he wrote. Add to that the collapsing demand for PCs among consumers, and the remaining pie to fight over appears to be shrinking.

With all those factors considered, Whitmore comes down in favor of the buyout: “With a proxy fight looming in a ‘no’ scenario in the Dell shareholder vote and PC industry fundamentals under considerable strain, we’d think twice before voting against a bird in the hand.”