The proposed Dell buyout may be motivated more by fear than greed.
Dell’s founder, Michael S. Dell, and the investment firm Silver Lake are offering to take the company private in a $24.4 billion deal. One interpretation of the offer is that savvy investors, using cheap loans, see a nice opportunity to unlock the value from a company that has fallen out of favor with stock investors. The fact that large shareholders are opposed to the deal, thinking it is priced too low, supports the idea that Dell is a diamond in the rough.
But there is an opposite interpretation: The buyout is a last-ditch effort to revive the company. To some, taking Dell private is what’s necessary to implement the sort of bold measures that could prevent the steady decline of a company that has been left behind in many of its markets. And like many acts of desperation, the risks are high that going private will fail.
This viewpoint starts with Dell’s cash flows. How much actual money a company makes each quarter is always an important metric. It’s especially critical at firms that go private in leveraged buyout deals. Once private, Dell would have a lot more debt – and it would need divert more cash to service it.
Going private may allow the company to slash costs, which preserves cash. But management may also feel liberated to spend more on initiatives it feels enthusiastic about, which would use up cash initially. In a botched buyout, management’s plans fail to produce results and a dangerous cash crunch occurs.
And there are some signs that Dell’s cash flows are weakening going into the deal.
The cash flow metric that matters is called free cash flow, which takes the money generated by Dell’s operations and then subtracts what the company spends on capital expenditures. Through the end of its latest fiscal year, which ended in February, Dell’s free cash flows were $2.77 billion. That is well below the $4.85 billion reported in the prior fiscal year. And the recent cash flows may have gotten a boost from financial moves that might be hard to repeat. In the most recent quarter, Dell generated a lot of cash from taking longer to pay its suppliers.
It’s easy to paint a grim picture from these numbers. A privately held Dell might have an extra $700 million to $1 billion of extra interest a year, which could in theory take annual free cash flows below $2 billion. That provides little margin for safety if Dell’s operations run into serious trouble, even if the company does decide to dip into its large pool of overseas cash.
But there are some reasons to believe this analysis is overly pessimistic.
First, the cash flow numbers probably don’t fully factor in how much cash can be generated by Dell’s recent acquisitions. Just as a couple of items helped bolster cash flows in recent quarters, others used up a lot cash, and may not do so in the future. For instance, Dell had a $450 million cash drain in the last fiscal year just from the “deferred income taxes” line. That could be the result of a one-off action rather than a recurring trend.
With all its acquisitions contributing, optimists might contend that Dell can produce $3.5 billion of free cash flow a year. If investors paid seven times that, the company would be valued at the $24 billion, which is where it is valued today on the stock market. Other shareholders think Dell is worth a lot more than $24 billion, and has the cash flows to justify it.
But right now, Dell’s cash flows are weakening. And if they continue to wane, Mr. Dell may soon have a tough job ahead of him. He may already know that — looking at those cash flows.
DealBook: In Dell’s Waning Cash Flows, Signs of Concern
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DealBook: In Dell’s Waning Cash Flows, Signs of Concern
