Down on Dell(2)

For investors in private equity, February felt like a flashback to the heady days of the boom era. First came confirmation of the $24.4 billion take-private of PC manufacturer Dell, backed by Silver Lake; then Warren Buffett’s Berkshire Hathaway partnered with Brazilian investment firm 3G Capital to buy Heinz for $28 billion.

The fact that two deals of this size got done certainly speaks to a renewed level of confidence in the debt markets. But for many in private equity, the bigger question is whether Silver Lake will be able to deliver a strong return on its Dell deal.

For some limited partners, there are certain aspects of this deal that might throw up red flags. For a start, it’s Silver Lake’s largest-ever equity cheque: the firm is contributing $1.4 billion, according to filings with the US Securities and Exchange Commission, most of which will come from the 2007-vintage $9.4 billion Fund III, sources say (not Fund IV, which is currently in market targeting $7.5 billion but may go as high as $9 billion). 

“It’s really difficult to know whether this is a good deal without being privy to what they expect to do with it,” says one LP. “Personally, I’m happy I’m not in it.” 

Some general partners are struggling to see how Silver Lake will be able to generate a private equity-like return on the deal. 

“This is a great example of the kind of investment that we would never be interested in,” says Rick Nathan, managing director at Toronto-based Kensington Capital Partners. “If you want to triple your money over a normal private equity timeline, you’re going to have to create $20 billion in new value or more over a three to five year period. [That’s] extremely difficult – there have not been many deals that have successfully executed that.”

Silver Lake declined to comment for this article. But judging by Dell’s recent acquisitions (and market chatter), its role may be to help the PC-maker become more of a software and services business, focused on small and medium-sized enterprises. 

“They’re betting a lot of capital in absolute numbers on a single transaction that is, in the best scenario, a complex reorganisation – which, by the way, several of these PC makers have gone through unsuccessfully,” says John Poerink, founder and managing partner of mid-market firm Linley Capital. “This by no means is a ‘slam dunk’ type of situation.”

While taking Dell private will allow the company to restructure without the pressures of quarterly reporting, it also means the business is saddled with a reported debt load of $15 billion.

“The debt on the balance sheet could potentially inhibit them from being more aggressive with respect to restructuring processes that they might have to go through,” says Poerink. “They’ve clearly analysed what their cash requirements would be – but what I can tell you is that reorganisation plans never go in the way that you expect them to go.”

Even if Silver Lake manages to turn Dell’s business around during a reasonable time period, the only viable exit route is likely an initial public offering, which brings significant uncertainty and extends the exit process (due to lock-in periods).

“Maybe you make two times your money,” says the LP. “That wouldn’t be horrible. But I don’t think a lot of these big deals have translated to a lot of great multiples. Maybe Silver Lake and Michael Dell have plans that are not obvious.”

The firm certainly managed to surprise a few people with Skype. Maybe it will this time too.