A few years after leaving the public markets, Dell Technologies Inc. is taking a back door to return.
The company announced Monday a complex plan to go public again that bypasses a traditional, underwritten initial public offering. Dell intends to convert a special stock that tracks the company’s stake in VMware Inc. VMW, +10.24% , known as class V shares, into class C common stock in Dell that will be publicly traded. There will also be an option for investors to cash out class V shares, which were created in the huge merger between Dell and EMC, and Dell says that a VMware special dividend will help fund the transaction.
Dell is offering $109 in cash for each share of class V stock, 29% higher than the stock’s closing price on Friday. Shares of Dell’s class V tracking stock rose 7.5% after the announcement, to about $91, while VMware shares jumped 10.2%, their biggest one-day gain in more than two years.
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Analysts appeared united in praising the deal as it avoids the prospect of a reverse merger between the two companies. Cowen analyst Gregg Moskowitz said the deal takes the threat of a “value-sapping” merger off the table, which had acted as an overhang on VMware shares.
“This is a clearly favorable outcome for VMware shareholders given the dividend and what we believe is the removal of the reverse merger threat for the foreseeable future,” Moskowitz said in a note. Moskowitz has an outperform rating on VMware.
Deutsche Bank analyst Karl Keirstead, who affirmed his $120 price target and buy rating on Dell class V shares, sees the deal as a positive to both class V and VMware shareholders.
“While Dell retains the right to pursue a business combination with VMware down the road, we conclude that access to the public equity markets, improving Dell fundamentals and a special dividend from VMware makes this a highly unlikely event for the next several years,” Keirstead wrote in a note.
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Following Dell’s announcement, VMware said it was paying out an $11 billion one-time special dividend, and that Dell’s share of the dividend will help fund the transaction, which is expected to close in the fourth quarter.
FBN Securities analyst Shebly Seyrafi said about $9 billion of the dividend will go to Dell and the rest to VMware shareholders. One downside is that VMware is left with $1.63 billion in gross cash, while net cash goes from $8.34 billion to a deficit of $2.6 billion, Seyrafi said.
“But we estimate that VMware will have a F2019 [free cash flow] of $3.34B, so we expect VMware to go back to a positive net cash position in late F2019,” he said.
Patrick Moorhead, principal analyst at Moor Insights and Strategy, told MarketWatch that the dividend likely was the result of negotiations between the two parties.
“The outcome was clearly that VMware wanted to stay separate, but they also wanted to show they were part of the happy Dell family,” he said.
Moorhead explained that if Dell and VMware had completely merged, channel partners might have viewed VMware differently, and “that would’ve caused a lot of discussion and some hand-wringing by companies like HPE HPE, +1.30% , Cisco CSCO, -0.51% , and Lenovo 0992, +4.94% , who are all routes to market for VMware.”
Moorhead said Dell presumably wanted to take advantage of friendly equity markets, particularly for tech companies. Though Michael Dell resents the practice of delivering quarterly earnings reports and facing regular questioning from Wall Street, Moorhead believes the company had enough time as a private company to execute on longer-term adjustments.
Analyst Roger Kay of Endpoint Technologies Associates said that Dell was able to do the deal because the company is in good financial shape, as Dell delivered a strong full-year forecast during a Monday conference call.
“What they’re saying is that their growth machine will be able to pay the debt and overcome everything,” he told MarketWatch.
Kay also suspects that the new tax bill might have prompted the transaction, since Dell likely has a “big tax liability” resulting from its overseas profits.
“Apple AAPL, +1.12% has the same sort of issue, but Apple has so much liquidity and so little debt that it could pay the tax bill and move forward,” Kay said.
Still, he said of the folks at Dell, “as financial engineers, there’s hardly anyone in the game that’s better.”
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As for VMware, the company reaffirmed its second-quarter earnings outlook of $1.49 a share, on a diluted share count of 413 million shares, on revenue of $2.15 billion, and revised its full-year earnings outlook. VMware now sees full-year adjusted earnings of $5.99 a share based on a diluted share count of 414 million shares, compared with its former outlook of $6.14 a share on a count of 410 million shares, and revenue of $8.78 billion. Analysts surveyed by FactSet estimate earnings of $1.49 a share on revenue of $2.14 billion for the second quarter, and $6.15 a share on revenue of $8.79 billion for the year.
After Monday’s big jump, VMware shares are up 29.3% on the year, while the S&P 500 index SPX, +0.31% has gained 1.7% in that time.
