March 05, 2018 - 1:51pm EST by
2018 2019
Price: 73.00 EPS 0 0
Shares Out. (in M): 199 P/E 0 0
Market Cap (in $M): 14,500 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 14,500 TEV/EBIT 0 0

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DVMT is a buy ahead of DELL strategic announcement


DVMT is the VMW tracking stock DELL issued to EMC shareholders when DELL bought EMC.  To learn more about this tracking stock, read this blog post from December.  It will give you a good overview of what the investment thesis was before DELL shocked the market with news it was considering an IPO or a reverse merger with VMW.

DVMT has also been written up numerous times on VIC however almost all of those are stale given the DELL announcement.  It's worth reading the comments in the latest DVMT article to see just how confused investors are.  Author u0422811


Put simply, most people thought at some point in the future, DVMT would convert to VMW.  Now, nobody thinks that’s every going to happen.  As a result, the spread went from ~35% discount in fall of 2017 to as much as a 50% discount post DELL news.  It’s currently a 37% discount.  This post is not advocating for putting on the spread but rather for going naked long DVMT.


DVMT fell from $88 Jan 25th to $73 today.  The entire move was based on the DELL news.  Earnings last week were solid.  VMW has fallen from $137 to $115 and has been downgraded by 4 firms due to DELL news.  Why is everyone so scared?


There are basically three options DELL can end up doing:


IPO, reverse merger, nothing.  The odds of DELL doing nothing are rather low, in my opinion.  DELL wants to accomplish two primary things:  It wants to pay down debt & get access to all of VMW’s cash flow.  The Tax Law put all this in motion.  There have been numerous Seeking Alpha writeups and two large sell side initiations in just the last week but I think they all miss the big picture:   


What’s the way Michael Dell and Silver Lake make the most money?  If we view DELL/DVMT/VMW as a pie and at some point in the future they all combine into one then the only question is how the pie is divvied up.  Obviously, DELL wants the biggest piece of the pie.  This is why the market has tanked DVMT and VMW.  It assumes that DELL will put an unfair valuation on itself and in a three way merger take an unfair amount of this pie.  I think they will!  But I also think the pie is so undervalued right now, there is enough for everyone to get full. I think I really messed up that analogy but let me explain:


Let’s hypothesize that VMW is worth $150 as a standalone company with no DELL ownership.  Put another way, if 100% of the outstanding shares of VMW traded freely and there was no controlling shareholder I believe VMW would be at least $150.  I arrive at this because it was $137 before and it definitely had a DELL discount imbedded given nobody can acquire it.  In a takeout it would probably be a lot more but let’s just use $150 as “fair value w/ no DELL”.  There are 80 Million or so VMW shares in the float meaning that the fair value of VMW float is $12 Billion.


DVMT has ~200m shares outstanding and each share is worth a bit more than 1 VMW (see the blog post for why).  If DELL wanted to, they could absolutely make this a reality in a few years.  It’s a real value that will almost certainly never be realized but that doesn’t make it less real.  200m X $150 = $30 Billion.  As we can see, the DVMT portion is worth much more than the VMW float and thus "stealing DVMT" is much more important than stealing VMW.


DELL wants to buy as much of DVMT as they can below that $150 price.  There are a few ways they can do this.  Currently, they are selling VMW stock to the company and buying DVMT in the open market.  The blog post goes into detail here.  They could do this indefinitely and create small value accretion over time.


The second option is to do an IPO and then convert DVMT into DELL stock.  They are allowed to do this at any time and the premium ranges from 20% to 10% depending on how long they wait.  If they did this, they would still have VMW float outstanding and it would be a complicated structure.  Further, it’s not at all clear DELL could pull off an IPO given the main value of the DELL equity will be their 80% stake in VMW.  Most of DELL CORE’s value is in the debt.


The third option, which according to the most recent article/leak is leading the pack, is a reverse merger with VMW and taking out the DVMT tracker “at a premium”.  This brings me back to the pie. In a fair world, VMW and DVMT would be valued at $150 in a 3 way merger.  Given this is all a stock swap, the only way to fairly value VMW and DVMT at $150 would be assigning a “fair” valuation to DELL CORE.  Let’s assume they do not do this.  What’s the best way for DELL to get the merger done w/ making everyone happy?


I believe they will value VMW at $150 and offer the float/minority holders a vote.  I think they will take DVMT out at $100-$110 and say it’s a 20% premium to the $88 unaffected price it was trading at before the news.  Mind you these numbers are indicative values, not cash takeout prices obviously.  It will all be a stock swap into a NewCo with DELL/VMW/DVMT all owning combined 100% of NewCo.


If DELL takes out DVMT at $110, he will create $8 Billion of value for himself and Silver Lake - overnight.  That’s 200 Million shares X $40 discount to DVMT “fair value”.  $8 Billion is a lot of money and it will be certain.  If he IPO’s, he has no idea what price DVMT will be in the future, no idea what the market will value DELL HoldCo at,  and has no certainty in being able to acquire all 200 million shares at sub $150.  He also still has a complex structure with VMW outstanding.


The market is terrified that DVMT has no value given there are two “disaster” outcomes.  One outcome would be merging with VMW and keeping DVMT outstanding.  Multiple articles have said this won’t happen and I don’t see why he would do that given he has every incentive to create billions for himself by taking out the tracker now.  The second outcome is a DELL IPO and the fear of forced conversion and not knowing what price you will ultimately get.  This fear is real but the market is missing that the value of DVMT to DELL is KNOWN.  It’s worth $150 a share.  DELL wants to buy as much of it as it can below $150 a share.  While DVMT holders have no power and complete uncertainty about what happens next, the opportunity has been created.


There are more questions that few have answers to.  For one, some believe DELL has to combine with VMW before it can ever spin out VMW shares to Michael Dell and Silver Lake.  I’ve tried to get a resolution on this but nobody knows the answer.  A DELL IPO would not satisfy this condition.  Also, will DELL give a vote to VMW minority holders or not?  One protection you have in DVMT is there is cross ownership with VMW which means many VMW shareholders will not vote for a deal without DVMT being taken cared of.


My homerun outcome is DELL values DVMT and VMW the same (as they should) and does it at $150 a share.  Note that DELL doesn't lose anything here he just doesn't steal any value from either class of shares.  It’s unclear to me how the DVMT three person board agrees to a deal that values DVMT at $100 and VMW at $150 given it’s a tracker to VMW.  Another outcome is he values them both at $125, stealing $7 Billion from VMW/DVMT.  Unclear if he could get this done given lawsuits and possible VMW minority vote.


From a reputation standpoint, while Michael Dell has left a sour taste in both his DELL LBO and his EMC takeout, Silver Lake has a large business to run outside of DELL and one would think they would care about not screwing VMW and DVMT shareholders. At some point, they need to sell their position and screwing shareholders is not the way to get a good value on NewCo.

Given the size of DVMT and VMW float, there is a non zero chance an activist gets involved especially as they both continue to go lower.  Unclear what if any moves an activist can take besides publicly shaming and ultimately filing lawsuits to try and block a bad deal.

I'd love to get a good dicussion going telling me where I am wrong here so comments are welcome.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Resolution of DELL strategic process.

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