DELL Risk Arbitrage

Initiated price: 13.10

Deal Price : 13.65

Expected Closing: August 2013

Break Price: $9.00

Based on these assumptions the deal offers 4% gross return or about 10% annualized at 89% market implied probability. The proxy can be found here. There has been considerable amount of action and material written on this deal but ultimately it looks like Michael Dell’s $13.65 is the only bid left though it’s possible Carl Icahn could offer a better price or wage a proxy battle for alternative proposal.

Many large insiders have sold their entire stakes including which OakMark sold ~1.4% stake in the company after Blackstone backed out of the go-shop period. Also there is speculation that T. Rowe has been selling some of their stake.

Here is a checklist of reasons why I like this deal:

1) The insider of selling I actually view as a positive development as it moves shares from agitators or longer term holders into arbitrage players who are more likely to go for the quick profit. With bidders and insiders backing out, $13.65 seems far more attractive.

2) SilverLake has a $750MM break up fee which is almost 3% of the market cap!

3) Reviewing the MAC clause in the proxy, it would seem that the company would have to show materially disproportionate decline in business compared to the industry.

4) As a PE company, DELL represents an excellent opportunity for a fund to deploy a significant amount of capital, will require years of lock-up, and the ability to charge a management fee waiting for a turn around. It actually seems an excellent deal for PE over Michael Dell or shareholders since they will be compensated somewhat regardless of what happens to the business.

5) According to the IDC report, DELL reduction in volume does not look THAT bad IMO:

Dell saw shipments decline by more than -10% globally and -14% in the United States. The vendor continued to face tough competition and struggled with customer uncertainty about the direction of its restructuring. Nevertheless, the decline in shipments was smaller than the past few quarters, and its sales to Asia/Pacific returned to positive growth.

6) The IDC report also seems to squarely place the blame on lack of enthusiasm for Windows 8 roll out as opposed to PC demand. It’s possible that changes to Windows 8, such as the Start Menu (really MSFT?) could boost demand for PC’s in the short run.

7) Sentiment is quite negative, both in terms of PC market and this name as well. It is actually bolstering Michael Dell’s negotiating position. In a recent letter he reiterated to employees that the transaction with Silver Lake was continuing and expect closing by August.

The real question I think is what will Silver Lake do? Items 2-4 share my thoughts on why I think it makes sense for them to continue with the deal. I have sold August 13 Puts as a position to take advantage of some implied volatility boost and to reduce carrying costs.

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