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Source: Barron's, February 16, 2013 commentary

Other Voices   |   SATURDAY, FEBRUARY 16, 2013

Dell Deal: The Same as Insider Trading


By its nature, a leveraged buyout by corporate insiders is a betrayal of their fiduciary duty to other shareholders.

Now for a few words about the proposed leveraged buyout of Dell, the estimable Michael S. Dell himself, and law and ethics.

We all like to make money on stocks. We all like to find a company whose stock price -- for any reason -- doesn't come even close to its real asset value, or its value if it were cleverly reorganized and produced better earnings. We like to then buy the stock and hope that the real value comes out in the price.

But not all of us have the same opportunities and the same duties under law and ethics. If a fine company like Dell (ticker: DELL) suffers reverses in its stock price and earnings because of how the market views the future of computing and connecting, we outside stockholders can buy a few shares of stock, just sit there, fingers crossed, and hope for better days.


Gary Hovland for Barron's

If you believe in truly independent directors when immense sums are on the table, you're a hopeful and optimistic human indeed. And one who perhaps hasn't spent much time among public companies' top managers.


But if you are Michael Dell or Dell's top managers or its investment bankers, you are in an entirely different position from the outside investors, even very large outside investors.

You are actually in a position to know in detail what Dell is worth, as a whole and segment by segment. You know how changes will move earnings and how much a breakup and sale will yield, compared with the stock valuation at any given time. You can buy the whole company.

That way, you can arbitrage the value of the company -- what you know to be its real value or, at any rate, its likely value -- against the stock price, and make some real money.

Insiders who did so by bringing their companies private over the decades include David Rockefeller with Rockefeller Center Properties and John Kluge with Metromedia. Six years ago, Richard Kinder took part in a privatization deal that left him owning 23% of Kinder Morgan (KMI), a stake worth nearly $10 billion now that the pipeline company is public again. And Thomas Frist Jr., co-founder of HCA (HCA), has taken that hospital-management company public and then private several times, amassing a fortune that Forbes estimates at $4 billion.

Barron's has raised real questions about the Dell deal. In several articles in print and online, the magazine's Andrew Bary has shown why the price of $13.65 a share looks way too low.

The real problem, to me, is that immense insider stockholders like Michael Dell and his managers are supposed to be fiduciaries for the little stockholders. They are required to put our interests ahead of theirs -- to forgo profiting at our expense, to avoid even the appearance of conflict of interest, and to disclose to us shareholders every material fact of every transaction. Like everyone else, they are forbidden to trade on insider information. (By the way, I own Dell only as part of an index fund.)

But in a going-private deal led by management or a founding stockholder, management by definition is trading on insider information. These insiders know far more about the company's value than we little fish. They're acting on that information by buying all of the corporation's stock. That's insider trading, in my view.

Again, they are fiduciaries. But they aren't putting their trustors' interests (the interests of the stockholders) ahead of theirs. They are putting their own interests first. If they didn't see the meaningful arbitrage between pre-deal market value and what they can squeeze out of Dell, they wouldn't do the deal in the first place. But if they see gains that could be obtained through better management or by liquidation in whole or in part, they're duty-bound to realize those gains for us, not for themselves. That is what it means to be a fiduciary.

WHAT'S MORE, BY DOING a going-private deal, Michael Dell (by all accounts a fine man) and his colleagues (all honorable men) are in an absolutely clear-cut conflict-of-interest situation. They are, in essence, bidding against their fellow shareholders. But they aren't showing all their cards.

In all going-private deals there are memos and other data showing the real value of the company and how much money will be made by the insiders and those who join them and finance them. Stockholders outside the buyout group don't see this material. This is yet another assault upon fiduciary duty -- withholding material information about a vital transaction–and, again, trading on that information.

The whole concept of fiduciary duty exists to prevent such things as going private, where the guardians of the trustors take advantage of their superior knowledge to make money off the trustors.

Supposedly, such things as subcommittees of independent directors protect the stockholders. But if you believe in truly independent directors when immense sums are lying on the directors' table, you're a hopeful and optimistic human indeed. And one who perhaps hasn't spent much time among public companies' top managers.

One of the smartest businessmen I know, a former high executive of a publicly held entertainment company, once asked me: "What is the first duty of a corporate CEO?"

"Well, to maximize the utility of the shareholders," I naively answered.

"You poor child," he said. "No, the CEO's first duty is to make himself as rich as he can, as fast as he can, with the shareholders' money." I'm sad to say that decades of observation have confirmed that his conclusion is correct all too often.

Finally, some will say that the price paid to the outside stockholders in a going-private transaction is investigated and approved in a "fairness letter" from a reputable investment bank (an interesting concept in itself). My experience, when digging into these deals, is that the fairness letters are done by summer interns or neophytes at the firm, match whatever price management cares to pay, and rarely stand up to careful examination.

For those who say Dell shareholders are getting more than the pre-deal market price, here's a simple suggestion: Allow those who wish to take the cash to do so and run. Let the others join the buyout group and participate on the same basis as Michael Dell and his pals.

That won't happen. In going-private deals, where really big money is on the table, there is one ironclad law for managers: The constant, me, is always greater than the variable, u.

BEN STEIN is an actor, writer, and TV and print commentator on business, finance and economics. A graduate of Yale Law School, he taught law at Pepperdine University for many years.


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