BArron's : VMware Looks Like a Risky Bet in Dell/EMC Deal

VMware Looks Like a Risky Bet in Dell/EMC Deal

Amid deal mania, Western Digital’s SanDisk acquisition and Lam Research’s $10.6 billion offer for KLA-Tencor look better than Dell’s deal for EMC.

What a mess. If Michael Dell’s deal to buy data-storage company EMC pleased anyone other than Michael Dell you wouldn’t know it.

EMC shares (ticker: EMC) are down 6% to a recent $26.10 since the deal, the largest ever in tech history at $67 billion, was announced on Oct. 12.

Dell offered $33.15 per share for EMC, and as Barron’s Andrew Bary noted shortly thereafter, that represented a nice arbitrage opportunity in EMC stock, which traded just under $28 at the time.

The arbitrage has only gotten more substantial as EMC stock has retreated and the spread has widened, now 22% below the offer.

As goes EMC, so go the shares of software vendor VMware (VMW), which is down 26% since the announcement, at a recent $58.18. EMC owns 81% of the shares outstanding of the company, and so VMware is also being scooped up as part of the takeover.

Stocks can certainly trade below the offer price in a deal, but so many aspects of this deal strike one as odd that there seems to be more at work than typical arbitrage.

Dell, which was taken private two years ago after a bitter battle with Carl Icahn and other public shareholders, is guaranteeing EMC holders $24.05 per EMC share in cash. In addition, for every one share of EMC stock, they will be given a little over a tenth of a share of a new tracking stock that will represent the EMC majority stake in VMware.

With EMC’s current price just above the cash component, it’s as if investors are saying they have zero interest in the VMware tracking stock.

WHAT COULD BE WRONG with this deal? Start with the fact that Dell will end up owning $50 billion (market value) EMC, plus 28% of VMware, by putting up just $4 billion in equity with the help of Silver Lake Partners, his financial sponsor. No wonder Michael Dell was smiling in TV interviews.

The rest will be funded by a massive $60 billion in debt. In return for issuing 223 million of VMware tracking shares—flooding a stock that has a float currently of 79 million shares—Dell and Silver Lake will not only have that one-third economic interest in VMware but will also retain 81% of the voting rights. Tracking shares have no vote.

The far greater decline in VMware shares compared with EMC stock suggests VMware common holders today are at least as unsettled by all this as EMC holders, if not more. VMware investors have always chafed at EMC’s control. Although Dell and EMC promise a new and dynamic company, most VMware shareholders would prefer not to be the caboose to two aging engines.

Furthermore, the deal was followed a week later by the revelation that EMC and VMware will form a joint venture to sell stuff for cloud computing. That baffled VMware holders, presenting the prospect of a whole new round of investment that will drive up expenses. Why was that kept secret until a week later?

Another surprise was in store Tuesday when VMware offered a forecast for this quarter below expectations. It was all too much amid the already abundant confusion, and VMware stock fell a fast 19% the following day.

Many concluded that the joint venture is a way for VMware to combat new competition from the cloud. But if VMware faces serious threats, getting swallowed up in a mysterious JV is not the way VMware holders would prefer their company to proceed.

Couldn’t anything better have been found? Perhaps not. EMC may have explored various options and found no takers outside of Dell. Couldn’t VMware have been split off as a fully separate company? That, too, seems never to have been in the cards. EMC CEO Joe Tucci has long maintained the importance of keeping his business and VMware closely linked.

WHAT TO DO NOW? Investors conceivably will in time warm to the tracking stock. That’s what VMware CEO Pat Gelsinger said on CNBC, defending the deal.

Maybe, but the immediate prospect is that Dell, facing an EMC shareholder vote in the new year, may sweeten his offer ever so slightly. If unease persists among holders, he could conceivably dig into his satchel and throw in an extra buck to the cash component.

Despite that prospect, there seems little reason to own EMC stock. There is arbitrage, but there is also an opportunity cost to being stuck in such a maze of a deal when stocks of companies such as Amazon.com (AMZN) and Alphabet (GOOGL) are soaring.

One prospect for the adventuresome is to buy VMware common stock, which will continue to trade even after the deal, as an option on a buyout.

A source close to EMC and Dell suggests there could yet be a deal to sell VMware in its entirety to a third party, if it becomes a sticking point for approval of the deal. Numerous parties are interested in VMware, the source suggests, and like EMC, the company is in a go-shop period where offers could emerge.

The stock is extremely cheap—even with the company’s challenges—trading at 2.6 times projected sales, and seven times projected earnings before interest, taxes, deprecation, and amortization. Nearly a quarter of VMware’s market value is in cash. If VMware was worth almost $80 before the deal, a takeout at its former value would be 35% upside from here.

THAT GAMBLE IS NOT for the faint of heart, however, and more cautious investors may want to look instead to two other tech transactions announced last week with much better prospects. On Wednesday morning, chip-equipment supplier Lam Research (LRCX) said it would buy fellow supplier KLA-Tencor (KLAC) for $10.6 billion in cash and stock. Analysts have called this a “transformative” deal for many reasons, not least of which is that the combined companies will now be equal in market value to Applied Materials (AMAT), which has long dominated the industry. Indeed, Lam could be a greater investment for years to come.

The other deal is hard-drive maker Western Digital (WDC) buying flash-memory chip maker SanDisk (SNDK). Plain old disk drives are being replaced by flash, the stuff you find in iPhones and other mobile devices. This deal is less straightforward than Lam-KLA, but it, too, could ultimately pay off for the acquirer.

FT : US may block Philips’ $3bn Lumileds sale

US may block Philips’ $3bn Lumileds sale

Philips’ $2.9bn deal to offload its lighting components business was thrown into doubt on Monday after US regulators expressed “unforeseen concerns” over the sale to a consortium of Chinese private equity investors.
The Amsterdam-based group said the sale of an 80 per cent stake in Lumileds, which makes car components and LEDs, was now “uncertain” after the Committee on Foreign Investment in the US highlighted worries over the deal.

CFIUS, which vets sensitive acquisitions of US assets by foreign companies for national security concerns, typically focuses on attempts by Chinese companies looking to buy into high-tech industries.
In March, Philips sold an 80.1 per cent stake to a consortium led by GO Scale Capital, an investment fund for GSR Ventures and Oak Investment Partners. Other members are venture capital funds Asia Pacific Resource Development and Nanchang Industrial Group.
Frans van Houten, chief executive of Philips, said he was confused why the regulator had intervened in the sale of a company that made lightbulbs. “We make simple LEDs for lamps,” said Mr van Houten. “I do not see the excitement, but that is not up to me.”
Concerns over the deal surfaced as Philips swung back to a profit for the three months to the end of September, posting net income of €324m after defeat in a patent battle dragged the company into a €103m loss last year.
Philips is in the process of spinning off the rest of its lighting business, marking an end to its 124-year link with the lighting industry, as it focuses on its more profitable healthcare and consumer divisions.
Mr van Houten said the company would make a decision on whether to sell the division or list it in an initial public offering by the start of 2016 at the latest, with the aim of completing the deal by that summer.
Sales in the group’s higher-margin healthcare business, which now makes up 45 per cent of the group’s total revenues, rose 2 per cent on a comparable basis to €2.6bn, as an improving US market helped mitigate a slowdown in China.
Mr van Houten said the heady days of double-digit growth in China were over. “China talks about the new normal,” he said. “The new normal for us means single-digit growth.”
Philips’ lighting business posted a 3 per cent drop in like-for-like sales. Mr van Houten said the planned disposal was on track to cost between €200m and €300m this year, and about the same next.
Across the group, total sales rose to €5.8bn from €5.2bn, aided by a 6 per cent increase in like-for-like sales in the consumer division, which makes everything from toothbrushes to headphones.
Mr van Houten said “mind-boggling” currency swings in emerging markets — which account for about a third of the business — knocked 1.6 percentage points off the group’s operating margin. But Philips’ margin still rose 0.7 percentage points year-on-year to 9.8 per cent thanks to internal cost-cutting and restructuring.
Shares in the group opened down nearly 3 per cent, but had rallied to €23.68 by midday.

>>> US Gapping down

Gapping down
In reaction to disappointing earnings/guidance: SOHU -1.3%, GLRE -0.6%

Select EU financial related names showing weakness (Credit Suisse (unchanged) priced its capital raise - share offering today) : NBG -5.4%, DB -2.7%, SAN -1.4%, HSBC -1%

Other news: ZINC -11.9% (announces $50 mln at-the-market equity program), VRX -5.2% (conference call amid flurry of articles this weekend discussing Philidor and Valeant's purported relationship; issues a statement, confirming the appropriateness of related revenue recognition and accounting treatment for its arrangement with Philidor), X -1.9% (in symp with peer AKS dg),MA -1.8% (USAA to switch accounts to Visa (V) from Mastercard (MA)), SNY -1.6% (still checking), KMI -1.3% (offering of 32 mln depositary shares,), ASML -1.1% (small pullback following last week's strength)

Analyst comments: AKS -6% (downgraded to Underperform from Neutral at BofA/Merrill), JNPR -3.5% (downgraded to Hold at Stifel), ATHN -2.5% (downgraded to Hold at Topeka Capital Markets), AXP -2.1% (downgraded to Sell at UBS), JOE -2% (downgraded to Mkt Perform from Outperform at Raymond James), DSW -1.7% (downgraded to Hold at Canaccord Genuity), KORS-1.6% (downgraded to Market Perform from Outperform at Cowen), M -1% (downgraded to Market Perform from Outperform at Cowen), C -0.9% (downgraded to Equal-Weight from Overweight at Morgan Stanley), VTR -0.8% (downgraded to Hold from Buy at Evercore ISI
)

>>> US Gapping up

Gapping up
In reaction to strong earnings/guidance: TREE +14.3%, CSIQ +6.1%, FBP +3.3%, XRX +1.4%, CXRX +1.1%, CHKP +0.7%

M&A news: PNY +36.2% (to be acquired by Duke Energy (DUK) for $60/share or ~$4.9 bln), NTI +7.1% (announces the receipt of a buyout proposal from Western Refining (WNR) for consideration valued at $27.62/unit)

Select Brazil related names showing strength: YPF +11.4%, BFR +8.7%, GGAL +8%, TEO +7.4%, OIBR +5% (receives proposal from Letter One to enter into exclusive negotiations with respect to a potential transaction with the objective of a possible consolidation of the Brazilian telecommunications sector), TSU +3.2%, VIV +2.5%, ITUB +1.6%

Chinese names involved in trasnaction: QUNR confirms Baidu (BIDU) share exchange with Ctrip.com (CTRP): QUNR +27.3%, CTRP +20.4%, BIDU +7.4%

Other news: OPTT +35.5% (Ocean Power Tech and Gardline Environmental announced a Memorandum of Understanding to jointly develop innovative metocean monitoring and maritime security systems), BDSI +16.1% (received a $50 million milestone payment from Endo International (ENDP) for FDA approval of Belbuca), TOUR +10.3% (likely in symp with CTRP), RDHL+4.9% (positive top-line results from its Phase 1 study of Yeliva), WTW +2.7% (cont strength), SKX +1.5% (modestly higher pre-mkt after last week's decline), V +0.9% (USAA to switch accounts to Visa (V) from Mastercard (MA))

Analyst comments: VFC +2.7% (upgraded to Overweight from Neutral at Piper Jaffray), PYPL +2.7% (added to Conviction Buy List at Goldman), AWAY +2.5% (upgraded to Outperform at Cowen), P +1.7% (upgraded to Outperform from Neutral at Macquarie), AMAT +1.3% (upgraded to Buy from Neutral at Nomura), CVLT +0.9% (upgraded to Overweight from Neutral at Piper Jaffray), GS +0.7% (upgraded to Overweight from Equal-Weight at Morgan Stanley)

>>> US Early premarket gappers

Early premarket gappers

Gapping up: QUNR +26.5%, NTI +15.6%, CTRP +14.3%, BDSI +13.8%, PNY +8.5%, BIDU +7.9%, PAM +5%, TOUR +3.8%, P +3.4%, GGAL +3.3%, PYPL +2.7%, AU +2.4%, MNKD +2.2%, WTW +1.9%, SKX +1.8%, RLYP +1.4%, XRX +1.4%, PRGO +1.3%, SDRL +1.2%, BHP +1.2%, MT +1%, STO +1%, FCX +1%, BBL +0.9%, V +0.7%, CHKP +0.7%

Gapping down: VRX -14.1%, AKS -7.1%, DB -2.6%, MA -2.3%, AXP -2.1%, TOT -1.7%, KORS -1.7%, SNY -1.6%, M -1.4%, SOHU -1.3%, ASML -1%

>>> Sharp sees H1 EPS of (JPY 50.78) vs 2.80 last year -- lowers H1 rev guidance

Sharp sees H1 EPS of (JPY 50.78) vs 2.80 last year -- lowers H1 rev guidance to JPY 1.27 trillion from JPY 1.30 trillion prior vs JPY 1.327 trillion last year

  • Co also lowers FY16 revenue guidance to JPY 2.7 trillion vs 2.8 trillion prior guidance vs 2.786 trillion last year.
  • Operating results downturned from the previous announce, due to sales decline and further drop in the market price from intensified competition in small- and medium- size LCDs for the smartphone business in the Chinese market.
  • Sharp Group intends to announce the forecast of net income attributable to Sharp Corporation, once it becomes possible to make a reasonable estimate of the impact on consolidated financial statements arising from materialization of structural reforms currently under consideration or in progre