Mergers & Acquisitions | Deal Professor | June 25, 2013, 3:10 pm

The Intricate Endgame for Dell

By STEVEN M. DAVIDOFF

What is going on with Dell? It’s not what you think as the options for Dell’s shareholders, other than a takeover by Michael S. Dell and Silver Lake, look increasingly limited.

The battle for Dell is now really all about what Carl Icahn is up to. Mr. Icahn and Southeastern Asset Management have been working hard to come up with an alternative to the Michael Dell/Silver Lake bid. Despite the hard work, nothing has panned out. It truly appears that it is all a maneuver to extract more money for shareholders from the current buyers.

In other words, it has become a giant game of chicken.

But the game is tilted against Dell’s shareholders. And to understand why, you need to examine how the endgame for the July 18 vote is shaping up.

Last week was proxy advisory week. Institutional Shareholder Services and Glass, Lewis are considering whether to recommend the deal to their clients. And so the parties were making presentations to I.S.S. to try to influence it.

The proxy advisory service recommendations are always important, but here even more so because only a few big shareholders may sway the deal. That is because the deal must be approved by shareholders who are not part of the buyout group, the so-called public float.

Right now, Mr. Icahn’s funds have 10.28 percent of the public float and Southeastern has 4.83 percent. Perhaps in their camp is T. Rowe Price, Yacktman Asset Management and Pzena Investment Management. All three funds have also expressed their displeasure with the buyout. If all these parties vote no, then according to the public information the Icahn camp has 21.83 percent of the public float. Mr. Icahn and Southeastern will then need nearly 30 percent more to put them into a position to block the transaction.

The key here is whether these and other institutional shareholders are on Mr. Icahn’s side. But they may not even own these shares anymore.

These funds are institutional shareholders that are not in the business of taking big risks, and they all own less than 5 percent of Dell, meaning they publicly report their Dell holdings only in each quarter. T. Rowe Price, for example, was selling Dell shares last quarter and may be selling right now. We just don’t know what the institutional investors own at the moment. It may be that they decided this was all too risky and sold.

Even Southeastern is becoming skittish. Despite its protests that Dell is worth $24 a share, Southeastern just sold 71.7 million Dell shares to Mr. Icahn at $13.52 each, below the $13.65 that Mr. Dell and Silver Lake are offering.

It’s a bit puzzling why Southeastern would do this in the middle of this contest and not wait until at least the proxy advisory service recommendations, but the bottom line is that Southeastern is not really a hedge fund in the business of taking risk. Southeastern most likely just preferred to lock in part of its losses and reduce its exposure. And by reducing its stake, Southeastern no longer owns more than 5 percent of Dell and it, too, can sell without having to disclose the information until the end of the quarter.

With the institutional shareholders uncertain, this leaves Mr. Icahn and perhaps other hedge funds. After all, Mr. Icahn was happy to buy Southeastern’s shares because the price was below Dell’s offer and he is, to put it politely, “risk-preferring.”

But again there is a puzzler here. If Mr. Icahn had simply bought shares in the market instead of spending a billion dollars or so to buy more of Southeastern’s shares, he would be much closer to his theoretical blocking position.

Perhaps Mr. Icahn firmly believes in his value case and is hoping the deal is rejected. In this case he just wants more shares from any source. But I am puzzled again because Dell’s stock will almost certainly decline if shareholders reject the deal. Why not buy then? And so, maybe the simple fact is that Mr. Icahn is preparing for the endgame by pocketing some extra cash in case the deal goes through.

The cash is not certain, though, because the conventional wisdom is that the endgame will be a close vote. But again, the dynamics work against shareholders opposed to the buyout.

According to Capital IQ and based on public information from last quarter, institutional holders like mutual funds hold 57 percent of Dell while hedge funds hold only 6 percent. The figures may have changed, but this does not appear to be a situation similar to Clearwire’s, where the hedge funds came in full force and were willing to fight for more money. Here, the game is devolving to Mr. Icahn as the lone holdout, and even he may be setting himself up to take the money at the end if the game of chicken doesn’t work.

Which leads us to what happens if the vote goes through. There is a lot of talk that this will be the mother of all appraisal actions, in which a court determines what the fair value is. The Dell case may become an example of how appraisal can be used as a remedy in these types of deals, but more likely it won’t.

Appraisal is a difficult course of action. In an appraisal proceeding in Delaware, a dissenting shareholder can get more or less than the value of its shares depending on the court’s determination. Shareholders also can’t bring appraisal as a class action, which means they have to pay out-of-pocket attorneys’ and related fees. It also takes years to pursue the action and collect any money awarded. Because of these barriers, appraisal rights are not often exercised, and when they are, it is usually only by the biggest shareholders.

Here, we have another clever idea in the Dell deal. Gary Lutin of the Shareholder Forum is organizing the Dell Valuation Trust to overcome the hurdles to appraisal. Shareholders will join together to hire lawyers, coordinate the process and share attorneys’ fees and other expenses.

Unfortunately, there are problems. First, the trust might be found to be selling a security that requires both registration with the Securities and Exchange Commission and the filing of a registration statement before shareholders can participate in the trust. The Dell Trust may even be found by the S.E.C. to be an investment adviser requiring its own S.E.C. registration.

Even assuming the trust can get past these issues, or that they do not apply to it, there is the problem that the trust is charging only a penny a share in administrative costs (with a minimum of $100 charged for shareholder). Lawyers are expensive and it is hard to see how they can pursue an appraisal action with this small sum. And Mr. Lutin reserves the right not to seek appraisal for the trust, something he may do once he realizes the costs involved.

The bigger issue is what will happen once shareholders exercise appraisal rights here. Two professors, Minor Myers and Charlie Korsmo, have written an excellent study of appraisal rights, “The Law and Economics of Merger Litigation: Do the Merits Matter in Shareholder Appraisal?”

The authors examined 141 appraisal proceedings over six years. They found that on average 1 percent to 6 percent of public transactions each year have appraisal rights. On the whole, they found that 92 out of 141 of these proceedings settled and in those that went to trial the parties seeking appraisal were remarkably successful in obtaining additional money.

The professors’ findings reflect the conventional wisdom that appraisal is a struggle and an expensive one, but because it is uncommon, Delaware judges tend to reward this effort.

However, let’s face it, if appraisal became common, the Delaware judges may not look so kindly on it and instead would view it as just another form of shareholder litigation to be treated summarily. So I am skeptical that appraisal is likely to be the new trend anytime soon. It was designed to be difficult for a reason and to channel shareholders toward litigation.

In the Dell case in particular, the board went out of its way to adopt procedures to appeal to the Delaware courts. As I’ve noted this may have been a hollow exercise because they focused on only two bidders, but the Delaware courts are likely to give them great credit in any appraisal proceeding for this. It may be that there is a big appraisal case looming, but it doesn’t seem like it would be Dell’s.

Given the costs and uncertainty, this just means that the likelihood of an appraisal proceeding, even with Mr. Icahn, may be lower than people think.

All this is contingent on the transaction going through. If it doesn’t, then we are left with the fear of an uncertain price and future for Dell, again something institutional investors abhor. It means that there are serious forces pushing this transaction forward. If those forces hold, this may not be quite the cliffhanger the conventional wisdom expects.

Copyright 2013 The New York Times Company