Dell is Going Private Case Study 1

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Why DELL going private?  Major reasons  Autonomy  Leadership  Strategy  Customers  Shareholders  ….. 3

Balance sheet 4

What is the deal? 5

Where did money come from?  Hypothetically speaking, Michael Dell and his partner decided to bring $20 billion of cash to the firm to pay off existing shareholders (other than Mr. Dell himself).  Data (Hypothetical assumptions)  Current market cap = $20 billion  Current stock price = $40  # of shareholders = 500 million shares  Need $20 billion plus premium  Suppose premium is additional $5 billion.  Then, a total $25 billion is needed.  However, Mr. Dell will tender $5B.  Finally, $20 billion is needed to consummate the deal. 6

Where did money come from?  Michael Dell and his partner decides to issue $20 billion of new debt by leveraging DELL’s assets.  This process is called Leveraged Buy-Out ( LBO )  LBO: The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. Read more: Leveraged Buyout (LBO) Definition | Investopedia cost of acquisitioncollateralLeveraged Buyout (LBO) Definition | Investopediahttp://  In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. Leveraged buyouts have had a notorious history, especially in the 1980s when several prominent buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet the obligation. Read more: Leveraged Buyout (LBO) Definition | Investopedia debt/equity ratioinvestment gradejunk bondsbankruptcyleverage ratiooperating cash flowsLeveraged Buyout (LBO) Definition | Investopediahttp:// 7

Specific Terms of Bond Issues  Data (hypothetical assumptions)  Current DELL’s bond rating = A-  Current T-bond yield = 1.5%  Credit spread of Corporate Bond with A- rating = 2%  Additional risk premium (LBO premium) = 2%  Assuming that bonds are issued at par ($100),  How many bonds they need to issue?  At what coupon rate?  Potential interest expense annually = ? 8

Several scenarios to think about…  Who are the major investors out there for DELL bonds?  What if DELL cannot find enough investors during LBO process?  What would major consequence of issuing more debt by leveraging assets be?  In terms of interest expense,  In terms of potential change in credit rating change,  In terms of potential change in financial distress,  In terms of potential change in ROE,  What if interest rate drops (or rise) significantly immediately after issuance?  What if MOODY’S downgrades DELL bonds? 9

Table 6.6 Bond Ratings and the Number of U.S. Public Firms with those Ratings at the End of

Corporate Bonds  Corporate Yield Curves  We can plot a yield curve for corporate bonds just as we can for Treasuries.  The credit spread is the difference between the yields of corporate bonds and Treasuries. Corporate Yield Curves for Various Ratings, March