Storage giant EMC (NYSE:EMC) signed a definitive agreement with Dell under which the latter will acquire EMC for $67 billion, with EMC-owned VMware (NYSE:VMW) remaining a publicly traded company.  EMC shareholders will receive $24.05 per share in cash in addition to a tracking stock related to VMware. For each EMC share, shareholders will receive about 0.111 shares of VMware’s new tracking stock (note: VMware’s stock was trading around $78-82 through the week prior to the announcement). As a result, the total combined purchase price stands at $33.15 per EMC share, taking the total value to $67 billion. Michael Dell, founder and CEO of Dell Inc, will head the combined entity after the deal closes. Mr. Dell maintained that the acquisition would not have a negative impact on Dell’s credit ratings.  Moreover, the combined company will focus on de-levering over the next 18-24 months following the closure of the deal. Dell will add almost $50 billion in debt to go through with the acquisition. Mr Dell and the consortium of investors would own about 70% of the combined company’s equity after the completion of the deal, excluding VMware’s tracking stock.
We have a $28 price estimate for EMC, which is in line with the current market price. EMC’s stock price fell by about 20% since the beginning of the year, before rallying by 15% this month.
- Dell-EMC Deal Finally Closes: A Look At How The Merger Could Impact HPE & IBM
- EMC Earnings Takeaways: Flash Array, VMware, Services Continue Growth
- EMC Earnings Preview: Storage Hardware Sales To Remain Suppressed, Services To Drive Growth
- Why You Should Take A Closer Look At EMC’s EPS Growth
- How A Worldwide Decline In Storage Systems Sales Impacts EMC
- How Valuable Is EMC’s Information Storage Business?
The Role of Silver Lake, Elliott Management And Other Partners
EMC faced pressure from large institutional investors in mid-2014 to spin off some of the fastest-growing businesses within the company such as Pivotal.  Key investor Elliott Management had taken a stake of over $1 billion in EMC, making it one of the top five institutional investors. The activist investor group constantly pushed EMC’s management for structural changes to aid shareholders.  On the other hand, EMC’s CEO Joe Tucci stuck to the “federation” business model, wherein some of the acquired companies operate as separate entities, while they still collaborate on products for large clients. According to Tucci, it made sense for EMC to continue as a federation since it can offer better products and services to big customers with integrated offerings from VMware and Pivotal. After months of speculation, EMC and Elliott management came to a standstill agreement in January, under which the latter agreed to refrain from publicly putting pressure on EMC to spin off VMware.  In return, two new directors were appointed on EMC’s board with support from Elliott Management. The agreement expired in September, after which fresh speculation began.  After the Dell announcement, Elliott Management released a statement supporting the merger. 
Private equity firm Silver Lake was instrumental in helping Dell go private in a $25 billion buyout back in 2013.  Funding for the EMC acquisition will partially come from EMC’s cash on hand (about $5.8 billion at the end of Q2) and additional common equity from Mr Dell, Silver Lake and other partners including MSD Partners and Singapore-based investment firm Temasek.  Silver Lake and Temasek will contribute an additional $3.5 billion to help pay for the equity portion of the deal. Some reports indicate that Silver Lake approached Lenovo, Hewlett-Packard (NYSE:HPQ) and Huawei to possibly sell off Dell’s PC business in order to help finance the deal. 
How This Deal Impacts VMware
Acquiring EMC’s data storage and related businesses makes sense for Dell to help it compete directly with HP and IBM (NYSE:IBM). EMC is a clear leader in the storage systems market, commanding a nearly 30% market share in worldwide factory sales of external storage systems, which Dell can add to its 6-7% share in the market. Comparatively, IBM and HP hold a 10-11% share in the external disk storage systems market. Moreover, Dell can now offer integrated IT offerings to enterprise clients with EMC’s data storage, content management, data security and cloud foundry offerings under its belt.
At the moment, Dell does not intend to sell VMware stock to finance the the transaction.  The introduction of the tracking stock adds liquidity and volatility to VMware’s shares, which could have a dilutive effect.  Moreover, having a close relationship with Dell could impact how competing IT firms sign enterprise license agreements with VMware. VMware’s shareholders reacted negatively to the acquisition news, with its stock falling by about 12% to about $70 before open on Monday before recovering slightly to $72 by the end of the day. VMware’s stock price further fell to $69 after markets opened on Tuesday.
However, we believe that VMware’s long-term growth prospects are likely to be unaffected by its parent company being acquired by Dell. VMware has a strong global customer base with market leading positions in key market domains including server virtualization, software-defined networking and hybrid cloud computing. As the company evolves from primarily an on-premise virtualization service provider to a cloud computing vendor, it could continue to capture a significant portion of the addressable market. With the fast-growing divisions expected to continue to boost top line figures for VMware in the coming quarters, we believe that the company is poised to capitalize on the shifting market trends. Moreover, Joe Tucci added that Dell and VMware could generate more than $1 billion in cost synergies over the next few years. 
The company released its expected preliminary Q3 results on Monday prior to the Dell-EMC announcement. VMware expects Q3 revenues to by around $1.68 billion, which is about 10% higher on a y-o-y basis, beating the midpoint of the guidance given by the company at the end of Q2. VMware is also likely to beat the guidance consensus EPS of $0.99 for the quarter with an expected Non-GAAP diluted EPS to be around $1.02.  We maintain our $86 price estimate for VMware’s stock, implying a market cap of about $36.5 billion.Notes:
- Michael Dell, MSD Partners, Silver Lake Lead Transaction to Combine Dell and EMC, EMC Press Release, October 2015 [↩]
- Billionaire Michael Dell Strikes $67B Deal For EMC In Biggest Tech Buy On Record, Forbes, October 2015 [↩]
- At EMC, Marriage Requires Investment, Wall Street Journal, July 2014 [↩]
- Hedge fund Elliott pushes EMC to split off VMware: WSJ, Reuters, July 2014 [↩]
- EMC Adds Two to Board As Part of Standstill Pact With Elliott, Wall street Journal, January 2015 [↩]
- Weeks After Standstill Deal Expires, No End to EMC Fight With Activists, Re Code, September 2015 [↩]
- Elliott Management Comments on EMC / Dell Transaction, Market Watch, October 2015 [↩]
- Dell to Buy EMC for $67 Billion, Wall Street Journal, October 2015 [↩] [↩]
- EMC SEC Filings, SEC, October 2015 [↩]
- Silver Lake Explored Sale of Dell’s PC Business Ahead of EMC Deal, Re Code, October 2015 [↩]
- VMware: The stock Will Suffer from Dilution, Says Mizuho, Barron’s Blog, October 2015 [↩]
- Why Dell’s EMC Bid Leaves VMware Looking Like Devalued Currency, Wall Street Journal, October 2015 [↩]
- VMware Reports Preliminary Q3 2015 Results, VMware Press Release, October 2015 [↩]