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EMC Faces $10 Billion Test to Counter Call for Breakup: Real M&A 2014-07-21 23:09:34.593 GMT

(For a Real M&A column news alert: SALT REALMNA <GO>.)

By Brooke Sutherland July 22 (Bloomberg) -- EMC Corp. needs to convince investors that keeping the company together is worth more than the estimated $10 billion that could be unlocked in a breakup. Activist investor Elliott Management Corp. has built a stake in EMC and is pushing the $58 billion company to spin off its publicly traded VMware Inc. software unit, according to a person familiar with the matter. While the average of five analysts’ estimates signals a breakup could unlock more than $10 billion in shareholder value, Royal Bank of Canada said management has a point in arguing that a split would weaken the parts and harm growth. “This looks good on paper, but because of the strategic value of that asset, it might not be that practical to spin it off or sell it,” Rajesh Ghai, a New York-based analyst at Macquarie Group Ltd., said in a phone interview. “There are reasons why EMC is structured this way.” EMC needs to do something to boost its stock price, according to Cantor Fitzgerald LP. The shares climbed just 1 percent in the three years before reports of Elliott’s stake, compared with a 52 percent rally for the Standard & Poor’s 500 Index. The content management and security divisions are less integral to EMC, which makes storage computers, and spinning off those assets is an alternative that could create $5 billion for shareholders, Macquarie said. Or EMC could consider more share repurchases or dividends, said Janney Montgomery Scott LLC. Representatives for Hopkinton, Massachusetts-based EMC and New York-based Elliott declined to comment.

Stock Frustration

Elliott has accumulated more than $1 billion in EMC stock, said a person familiar with the matter, who asked not to be named because the information isn’t public. Splitting with VMware could make EMC an attractive takeover target for technology giants including Oracle Corp., said the person. Investors frustrated with the laggard stock may be receptive to Elliott’s proposal, Steven Milunovich, a New York- based analyst at UBS AG, wrote in a report yesterday. Even after EMC rose 5 percent yesterday, it still has a lower price-earnings ratio than the median for peers larger than $5 billion, according to data compiled by Bloomberg. While the company’s primary information storage business has been under pressure as more businesses shift to cloud storage, the unit is worth more than shareholders are giving it credit for, said Brian Alexander of Raymond James Financial Inc.

Underappreciated Core

Investors are “not really valuing EMC on a sum-of-the- parts basis because they haven’t had a reason to,” Alexander, a St. Petersburg, Florida-based analyst, said in a phone interview. Using a breakup to highlight “the valuation of core EMC, which we would argue is very depressed, makes a lot of sense to us.” EMC’s core business is valued at about 7.8 times estimates for earnings per share over the next year, Bill Choi of Janney wrote in a report yesterday. That’s almost half the multiple of pure-play rival NetApp Inc., he said. On average, analysts estimated that a breakup would boost EMC’s share price to as much as $33.60, 19 percent more than yesterday’s close. That equates to about $10.8 billion, data compiled by Bloomberg show.

Bigger Picture

Just because a breakup looks attractive financially in the short term, that doesn’t mean it’s the best strategy for EMC, said Amit Daryanani, an analyst at RBC Capital Markets, a unit of Royal Bank of Canada. Severing the ties between EMC and VMware risks undermining expansion at both businesses, he said. “I can make the case that EMC storage does much better in VMware-centric environments versus non-VMware,” the analyst said in a phone interview. “The federation grows faster than the standalone entities would.” One example of how closely EMC and VMware work together is their joint venture called Pivotal, which will help the companies gain relevance in cloud computing. VMware’s software that lets computers run different operating systems also gives the company an advantage as it competes with large rivals such as Oracle, Cisco Systems Inc. and International Business Machines Corp., said UBS’s Milunovich. “If you break it up, you just weaken every part,” EMC Chief Executive Officer Joe Tucci said at a conference in May. “So I just think it’s better together.” EMC would also still be a big takeover target even without VMware and getting rid of the holding wouldn’t increase the likelihood of a deal, said Daryanani of RBC.

Activist Spark

Still, the entry of an activist investor “was a long time coming,” he said. Whether or not the company decides to pursue a breakup, Elliott’s involvement should at least spark conversations about how to boost shareholder returns, he said. “There’s a lot of value at EMC, but it’s not being appreciated by the market,” Brian White, a New York-based analyst at Cantor Fitzgerald, said in a phone interview. “That’s what they need to grapple with -- how do they show that value to shareholders?” One alternative to separating VMware from EMC is to spin off smaller assets, such as the content management and RSA security divisions, said Ghai of Macquarie. “Those are two businesses that could easily be hived off to unlock some value that’s probably not being reflected in the shares right now,” Ghai said. It’s also possible that EMC instead decides to focus on returning more cash to shareholders with a dividend boost or increased stock buybacks, said Choi of Janney. Ultimately it will be up to shareholders to decide what they think is the best path for the company, said Brent Bracelin, a Portland, Oregon-based analyst at Pacific Crest Securities. “EMC is an undervalued asset,” Bracelin said in a phone interview. “A breakup would be able to unlock the value probably in a shorter period of time but ultimately, in the long run, does that actually mean that profitability would be higher? Maybe not.”

For Related News and Information: EMC Said Targeted by Activist Elliott for VMware Separation NSN N92M4H6S972D <GO> EMC Projects 2014 Earnings That May Miss Analyst Estimates NSN N4I9806KLVRY <GO> Symantec Breakup Is Best Hope to Revive Cheap Stock: Real M&A NSN N3BI4S6TTDSB<GO> EMC financial analysis: EMC US <Equity> FA PGEO <GO> Real M&A columns: NI REALMNA <GO> Top deal stories: TOP DEAL <GO>

--With assistance from Beth Jinks in New York.

To contact the reporter on this story: Brooke Sutherland in New York at +1-212-617-0448 or bsutherland7@bloomberg.net To contact the editors responsible for this story: Beth Williams at +1-212-617-2307 or bewilliams@bloomberg.net Whitney Kisling

After Hours Summary: SANM +12.2%, CMG +10.1%, NFLX +0.9%, UCTT -8.1%, RMBS -3.6%, TXN -0.6% following earnings/guidance

After Hours Gainers: Companies trading higher in after hours in reaction to earnings: SANM +12.2%, CMG +10.1%, TGTX +5.4%, HLX +4.8%, CNI +1.1%, CYS +1.1%, STLD +0.9%, NFLX +0.9%, TRST +0.2%

Companies trading higher in after hours in reaction to news: FBRC +6.6% (announced self tender offer to purchase up to 1 mln shares, or about 9.9%, of its outstanding common stock, at a price of not less than $28 and not more than $29 per share), SNTA +5.7% (announced advancement of ganetespib into Phase 3 extension of AML LI-1 study for patients with AML and high-risk MDS; follows positive interim analysis of Phase 2 results), TGTX +5.4% (announced preliminary clinical results from ongoing Phase I study of TG-1101 (ublituximab): 100% of CLL/SLL patients had significant nodal reduction with either a normalization of or =80% reduction in Blood Lymphocyte Count), APA +4.6% (hearing that JANA Partners has established $1 bln position and is urging further divestitures), GST +3.6% (reported 43% increase in mid-year proved reserves), ACT +2.71% (co and Medicines360 announced FDA acceptance for filing of NDA for Levosert IUD), MM +1.3% (higher following Yahoo acquisition of mobile-analytics co Flurry)

After Hours Losers:

Companies trading lower in after hours in reaction to earnings: UCTT -8.1%, RMBS -3.6%, ATR -2.9%, STFC -2.3%, POL -2%, RCII -1%, TXN -0.6%, HXL -0.5%, GLF -0.4%, ZION -0.1%, PKG -0.1%

Companies trading lower in after hours in reaction to news: TEP -5.0% (announced follow-on public offering of 7 mln common units), ITI -2.1% (announced receipt of Notice of Noncompliance with NYSE MKT Listing Standards)

Apache higher by 5% in after hours trading; hearing JANA Partners has established $1 bln position and is urging further divestitures

Asian Market Update: Japan govt cuts GDP forecast; China's CBRC warns on bad loans, while PBoC skips daily drain

***Economic Data*** - (CN) CHINA JUN CONFERENCE BOARD LEADING ECONOMIC INDEX M/M: 1.3% (7-month high) V 0.7% PRIOR - (TW) TAIWAN JUN UNEMPLOYMENT RATE: 4.0% V 4.0%E - (AU) Australia ANZ Roy Morgan Weekly Consumer Confidence Index: 113.5 v 108.7 prior - (US) NORTH AMERICA JUNE SEMI BOOK/BILL RATIO: 1.09 V 1.00 PRIOR (8-month high)

***Index Snapshot (as of 02:30 GMT)*** - Nikkei225 +0.9, S&P/ASX flat, Kospi +0.2%, Shanghai Composite +0.4%, Hang Seng +0.9%, Sept S&P500 +0.1% at 1,968

***Commodities/Fixed Income/Currencies*** - Dec gold -0.1% at $1,314, Aug crude oil flat at $104.58/brl, Sept Copper +0.4% at $3.21/lb - (CN) PBoC won't conduct open market operations (OMO) in today's session (1st halt after 6 drains) - (JP) BOJ offers to buy ¥300B in 1-3yr JGB, ¥200B in 3-5yr JGB, and ¥20B in inflation-indexed bonds

***Market Focal Points/Key Themes*** - Shares of Netflix sustained their recent rally despite an in-line Q2 report and soft Q3 guidance, as total net adds of 1.69M were well ahead of 1.46 prior forecast. Chipotle shares hit record highs afterhours near $650 after crushing Q2 sales and earnings and guiding SSS higher. TXN is up marginally despite a beat on top and bottom lines as well as a record high gross profit margin, while STLD is up an impressive 7% on strong sales and rising shipments.

- China June economic assessment from Conference Board increased at the highest rate in 7 months. Resident economist said the June pickup "is unlikely to be fully felt until the final quarter of the year, even though slight monetary loosening and better export performance could underpin more economic activity sooner." Also of note in China, the PBoC skipped its regular repo drain for the first time in 7 scheduled operations in spite of the high lending volume reported last month. Traders noted the deferred operations sought to keep a cap on liquidity ahead of the anticipated IPO launches in the coming days. Separately, China Banking Regulatory Commission (CBRC)'s Yan Qingmin called for mainland banks to accelerate bad loans write off, expressing concern over the possibility of rising NPLs.

- Japan govt cut its economic projection for real GDP in FY14/15 to 1.2% from 1.4% as had been speculated in local press. Fin Min Aso put the blame on lagging exports amid soft demand from emerging economies. Meanwhile, a Sankei survey revealed disapproval rating for PM Abe's cabinet climbing 6pts to a record high above 40%. Econ Min Amari also reiterated the govt will not make a decision on another sales tax hike until this December.

- USD majors are once again flat across the board with the exception of AUD/USD. The aussie dollar spiked up about 20pips against the greenback toward the $0.94 handle after RBA Gov Stevens neglected to mention or to attempt to talk down the exchange rate as had been widely speculated by traders going into his address at the Anika Foundation Luncheon. Note that Australia will also release its quarterly CPI data tomorrow.

***Equities*** US markets: - SANM: Reports Q3 $0.53 v $0.48e, R$1.60B v $1.55Be; +11.8% afterhours - CMG: Reports Q2 $3.50 v $3.05e, R$1.05B v $980Me; +10.1% afterhours - STLD: Reports Q2 $0.31 v $0.31e, R$2.06B v $1.97Be; +7.5% afterhours - APA: Jana reportedly discloses $1B activist stake in investor letter - financial press; +4.5% afterhours - NFLX: Reports Q2 $1.15 v $1.14e, R$1.34B v $1.34Be; +0.7% afterhours - JNJ: Announces $5B share repurchase program (approx 1.7% of market cap); +0.6% afterhours

- TXN: Reports Q2 $0.62 v $0.59e, R$3.29B v $3.26Be, Guides Q3 $0.66-0.76 v $0.68e; -0.1% afterhours - RCII: Reports Q2 $0.38 (adj) v $0.38e, R$773M v $781Me; Cuts FY14 guidance; -1.0% afterhours

- CROX: Reports Q2 $0.36 v $0.31e, R$376.9M v $372Me; to close or sell 75-100 of its 600 stores; to cut approx 180 (3.6%) of 5.0K workers; Halted

Notable movers by sector: - Consumer Discretionary: Panasonic 6752.JP +2.1% (to sell mobile phone base station to Nokia) - Financials: China Taiping Insurance 0966.HK +1.7% (H1 guidance) - Materials: Discovery Metals DML.AU +2.3% (Q4 mining results); Zijin Mining 2899.HK +1.1% (H1 results) - Energy: China Petroleum & Chemical 386.HK +1.8% (H1 results) - Industrials: Macquarie Atlas Roads MQA.AU +0.9% (Q2 results) - Technology: Toshiba 6502.JP -0.3% (said to be seeking $1.1B in damages from SK Hynix for illegally obtaining and utilizing flash memory technology) - Telecom: China Telecom 728.HK +1.5% (Reports June subscriber metrics)

Senate Report Says Hedge Funds Saving Billions With Tax Avoidance Technique

Companies Claimed Lower Long-Term Capital Gains for Trading Activity

WASHINGTON—Hedge funds used a tax avoidance technique offered by Wall Street banks for years to skirt federal leverage trading limits, with one well-known trading firm potentially avoiding $6.8 billion in U.S. taxes, Senate investigators claim in a report released Monday.

Companies involved in the practice have pushed back against the Internal Revenue Service, which warned in a 2010 memo against claiming a tax break based on the use of financial products known as basket options. The companies said use of the products to claim lower long-term capital gains tax treatment for trading activity is legal and doesn't violate tax rules or leverage limits under current law.

The report by the Senate Permanent Subcommittee on Investigations suggests the practice was widespread in the financial industry over the last 15 years or so, with one hedge fund, Renaissance Technology Corp. LLC, potentially saving $6.8 billion in federal taxes.

Investigators said two banks, Deutsche Bank AG and Barclays Bank PLC, sold 199 basket options to more than a dozen hedge funds, which used them to conduct more than $100 billion in trades.