Dell Inc. (NASDAQ:DELL) faces the same decline in PCs that other companies face. Rival Hewlett-Packard Company (NYSE:HPQ) reported that PC shipments sunk 14% in the first quarter. The company also projected that tablet sales (as a whole) would exceed the sales in PCs. Both Dell and HP are largely levered to the desktop and PC markets – two products which are no longer growth drivers in electronics.
As Dell Inc. (NASDAQ:DELL) reports earnings this week and Hewlett-Packard Company (NYSE:HPQ) reports next week, many analysts are fearful that the drop in traditional PC sales will continue its negative trend. Hewlett-Packard, more so than Dell, has exposure to the consumer market. Dell Inc. (NASDAQ:DELL) still derives the majority of its profits from enterprise computing markets, which is experiencing a much slower decline.
But where there are slowing sales, there is still an opportunity to profit.
Why Dell is worth a play
Last week, Carl Icahn and Southeastern Asset Management made a new offer to Dell Inc. (NASDAQ:DELL) shareholders. The activist-institutional duo of investors support a new plan to pay out a beefy $12 dividend per share and keep Dell as a publicly-traded company.
Dell currently trades at $13.45, below the $13.65 per share that Micheal Dell and a group of insiders agreed to pay for the company to take it private.
Carl Icahn calls that deal “insulting to shareholders’ intelligence,” both because it is below Icahn’s offers, and because the board of directors seem much too eager to take the lower bid. Meanwhile, the company also promised Micheal Dell a breakup fee of $450 million in the event the company selects a different offer. In an SEC filing, Icahn spoke directly to the board, addressing the fact that Dell’s original bid effectively allowed the founder to acquire the company with the company’s own money.
Icahn’s offer is incredibly alluring. First, it would require only $5.2 billion in new debt, using much of the cash Dell has on hand to pay out a $12 per share dividend. Next, it would allow current minority equity holders to remain shareholders, enjoying much smaller, more levered Dell shares that Icahn insists would trade anywhere from $1.98 to $5.35. The range, though wide, is well above the offer from Micheal Dell. Plus, unlike offers from the founder or The Blackstone Group L.P. (NYSE:BX), which made a competing offer it has since withdrawn, the minority shareholder can continue to participate in a turnaround.
Icahn isn’t playing around
Carl Icahn may be known for his colorful language and aggression toward corporate boards of directors, but when it comes to Dell Inc. (NASDAQ:DELL), he isn’t playing around. His latest proposal comes with strong language, insinuating that if the board rejects his offer, he’ll elect a new slate of directors who will accept it at the annual meeting.
This makes for a compelling low-risk, much higher reward trade for investors. On one end, Dell shareholders stand to make $.20 should Micheal Dell acquire the company and take it private.
If Carl Icahn gets his way, and Dell Inc. (NASDAQ:DELL) pays out a $12 dividend, investors would recoup nearly all of their investment and hold on to their ownership in the company. After saddling the company with debt to pay out a cash dividend, the company would generate “$0.50 and $0.89 in annual near-term pre-tax EPS” according to numbers from Icahn and Southeastern. An earnings multiple of 6 gives the remaining equity a valuation of at least $3 per share.
As such, investors would receive $12 in cash as a dividend and enjoy their continued ownership in a “stub” worth $3 per share. The offer is, essentially, worth $15 per share, and well in excess of Micheal Dell’s offer.
Icahn’s conviction is demonstrated by the fact that neither Icahn Enterprises or Southeastern Asset Management will take a $12 cash dividend for their shares, instead taking an equal amount of additionally equity that levers their interest to the continuation of the enterprise post-recapitalization.
Deals like these are often discouraged because investors saddle the company with debt to cash out with borrowed money. Neither Icahn nor Southeastern Asset Management have any plan to do that.
The best trade in technology
Whereas Hewlett-Packard Company (NYSE:HPQ)’s stock price is contingent on future earnings in a declining consumer market, investors who buy Dell are essentially playing an arbitrage game. If the coin flip lands on heads, investors don’t make much – just a small premium to the current market price if Micheal Dell succeeds with his bid. If the coin lands on tails, investors stand to make much more when a dividend is paid by Icahn and company and the “stub” finds a more reasonable valuation on the public market.
For this reason, cash-rich Dell Inc. (NASDAQ:DELL) is one of the most compelling plays in tech. The upside is enormous should Icahn prevail, with downside moderated to the opportunity cost of tying up capital in the company until Micheal Dell takes it private.
The article An 89% Dividend Yield That Isn’t Too Good to be True originally appeared on Fool.com and is written by Jordan Wathen.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
