Dell Inc. (DELL), Icahn: What To Expect

Last week, Carl Icahn’s Icahn Enterprises LP (NASDAQ:IEP) teamed up with Southeastern Asset Management to propose a leveraged recapitalization for Dell Inc. (NASDAQ:DELL). Icahn Enterprises LP (NASDAQ:IEP) and Southeastern, along with some other top Dell Inc. (NASDAQ:DELL) shareholders, have been upset by company founder Michael Dell’s recent attempt to take the company private.

Dell Inc. (NASDAQ:DELL), working with private equity shop Silver Lake Partners, has agreed to buy the company for $13.65 per share in cash. However, Icahn and Southeastern believe that Dell Inc. (NASDAQ:DELL) is undervaluing his company, and have gone so far as to call the go-private plan “The Great Giveaway.” The Icahn-Southeastern offer is now set to be the main alternative for Dell Inc. (NASDAQ:DELL) shareholders.

However, Icahn may be overestimating Dell’s earnings power, especially in the short term. New management would need to rapidly stabilize Dell’s profitability through cost cuts under Icahn’s plan. This plan seems excessively risky for shareholders, particularly because Icahn’s financial plan for Dell assumes a “rosy” scenario that may be unrealistic.

Great expectations
Icahn’s plan would not give shareholders as much cash up front as Michael Dell’s $13.65-per-share offer. Nevertheless, Icahn has said that his offer is clearly superior because it would allow current shareholders to share in Dell’s upside. Under his proposal, shareholders would receive $12 in cash but would continue to own a “stub” stock (with an estimated value of $1.65).

Alternatively, shareholders would have the option to decline the cash payment in return for 7.27 additional shares. Icahn and Southeastern (which together control nearly 13% of Dell stock) both intend to exercise this option, and they believe that some other shareholders will join them. They assume that the holders of 20% of Dell’s shares will choose extra stock over cash, while the other 80% would take the $12 special dividend (for a total payout of roughly $17.3 billion).

The crux of Icahn’s argument is that the stub stock, nominally valued at $1.65, would actually be worth far more than that. He argues that under new management, Dell could produce pre-tax EPS between $0.50 and $0.89 after the leveraged recapitalization. While Dell’s pre-tax adjusted EPS was more than $2 last year, several factors make Icahn’s estimated earnings range for Dell appear overly optimistic.