As Dell Buyout Vote Approaches, Scenarios Emerge, and They’re Not Pretty

Executives at Dell are beginning to make contingency plans for one possibility they now think likely — that the $24.4 billion buyout plan proposed by CEO Michael Dell and the private equity firm Silver Lake will fail a shareholder vote.

As the July 18 shareholder vote on the buyout approaches, and the wrangling over competing proposals reaches the endgame phase, the two sides on the chess board — Michael Dell and Silver Lake on one, and the activist investor Carl Icahn on the other — are faced with the very real possibility that neither will get what they want.

An opinion by the proxy advisory firm Institutional Shareholder Services is expected next week. And, according to numerous media reports, ISS is not expected to come down in favor of the buyout. If that were to happen, many large shareholders would vote against the deal, making it unlikely that a sufficient majority would vote in favor.

A “no” vote on the buyout would, as one source close to the company put it, “create a certain amount of chaos” at the company, with several possible outcomes. First and foremost would be a battle between Michael Dell and Icahn for control of the board. Icahn, the second-largest shareholder in the company, and his partner in a proposed recapitalization transaction, the investment firm Southeaster Asset Management, proposed a slate of directors on May 13. Michael Dell and other shareholders would presumably float their own slate of directors that looks a lot like the company’s current board. (One Dell director, the former Pennsylvania congressman William H. Gray, died unexpectedly on July 1.)

It’s considered highly unlikely that Icahn could succeed in convincing shareholders to elect his entire slate of directors. The election of Icahn’s full slate is required before he would be allowed to tap the $5.2 billion in financing he said he had raised earlier this week to fund his recapitalization plan. Here, the voice of ISS would carry weight as well, as the firm also advises shareholders on board elections, and typically recommends against some directors being reelected.

The result, sources say, could then be a “mixed board,” containing some directors loyal to Icahn, some to Michael Dell. Such a board would have difficulty agreeing on a strategy to get the company growing again.

The Michael Dell-Silver Lake plan envisions an aggressive strategy of investment that would lead to a new iteration of Dell focused less on personal computers — which, when combined with PC peripherals like monitors, account for more than two-thirds of its business — and more on sales of enterprise hardware, software, services and networking.

Icahn and Southeastern have proposed using Dell’s existing supply of cash and new debt to pay a special dividend to existing shareholders. He has also variously proposed selling off certain assets of the company. Part of the plan includes offering shareholders $14 a share for up to 72 percent of the outstanding shares of the company, but leaving the remaining shares as a publicly traded “stub.”

Pressure has been rising on Michael Dell to raise his bid above the proposed $13.65, and he has not yet indicated any willingness to do so. Silver Lake is seen as unlikely to raise its portion of the bid. The pair raised their bids in negotiations with the board’s special committee six times before settling on that price.

But, after the buyout vote, one key factor on the corporate governance front will change: Michael Dell will be allowed to vote his proxy again. He remains the company’s largest shareholder, about 16 percent of shares outstanding. And while prohibited by the rules of the go-shop process from voting on the buyout, he will be able to vote his shares against any proposals by Icahn, including the board slate.

And here’s where it gets interesting. As Dan Primack of Fortune noted on Wednesday, in the event that Icahn is able to carry out his recapitalization plan and convinces a majority of shareholders to tender their shares, Michael Dell could hold on to his shares. In that event, he would end up controlling more than 40 percent of the proxy. That would set up a scenario where he might bide his time, let an Icahn-controlled company proceed on its way for awhile, then exercise his shareholder’s prerogative and retake control later, thus choosing to lose the battle now to win the war later.

Meanwhile, for current investors, there’s the question of Dell’s share price. Buoyed by the $13.65 buyout bid, its shares are trading at a forward price-to-earnings ratio higher than 10. Dell’s primary rival, Hewlett-Packard, is trading at a forward P/E of less than seven.

This implies, by no small stretch of argument, that without the buyout bid, Dell’s shares should be trading at about $8.50, or about 36 percent lower than they closed at on Wednesday, and perhaps even less. In materials filed moments ago with the U.S. Securities and Exchange Commission, Dell argued that, failing approval of the buyout, Dell shares would suffer from “significant downside risk,” as based on various assumptions they could trade as low as $5.85 a share.

A failed buyout vote, coupled with a failure by Icahn to consummate his recapitalization plan, would, failing a significant turn in its business prospects, push Dell’s share price down. This would complicate other problems, not the least of which would be the ability to hire and retain employees with stock options. It would also create a narrative that Dell is facing a corporate death spiral, making customers wary, and its future more uncertain. It would also create an opportunity for rivals like HP, IBM and others to pounce and capitalize on Dell’s perceived weakness.

One thing is certain: If the buyout vote fails, the battle for control of Dell itself will begin for real.