What's in your portfolio? Dell debt, most likely

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Michael Dell is accounting for the lion's share of the cash and equity in the proposed buyout of his company.

Without realizing it, defined benefit and defined contribution plans could be betting on a Dell Inc. turnaround.

Should the proposed management buyout go through, there could be more than $24 billion in Dell bonds outstanding, between existing issues and new debt from the buyout. Depending on the ultimate terms and price of the debt and loan offerings, investors could find Dell instruments scattered throughout their fixed-income, hedge fund and alternative investment portfolios.

On Feb. 5, founder and CEO Michael Dell and private equity firm Silver Lake Partners announced they were leading a management buyout of the computer company for about $24.4 billion.

As a so-called “benchmark name,” investors — including mutual funds and exchange-traded funds as well as institutional investors through traditional separate accounts and index funds — would have to have exposure to the debt and loans, sources said.

Dell's new and old debt could amount to about 20 basis points of the $1.2 trillion market capitalization of the Barclays U.S. Corporate High Yield index, which is big enough to have an impact on managers' investment decisions.

“Assuming this deal happens, defined benefit plans and defined contribution accounts will probably still own Dell securities (as a private company) if they invest in bank loan or high-yield bond investment vehicles,” said David Fann, president and CEO of San Diego-based consulting firm TorreyCove Capital Partners LLC.

But, under the current proposed debt structure, which is not typical for leveraged buyouts, Dell debt and loans could show up in investment-grade portfolios as well, sources said.

The amount of debt would be “big enough to be noticeable,” by managers and investors, said Michael Rosen, chief investment officer of Santa Monica, Calif.-based consulting firm Angeles Investment Advisors LLC. It could be enough for money managers to have to make a decision if they want to be overweight or underweight, he said.

There will be a lot of interest in new Dell bonds and loans, Mr. Rosen predicted. “We're in a market where there's insatiable thirst for high-yielding paper,” he said, because of the low-yield environment.

Possible downgrade

On the other hand, completion of a Dell buyout will not be a happy time for current holders of Dell debt. About $7.6 billion of Dell investment-grade debt being held by money managers now could be downgraded to non-investment-grade, said Jeffrey Golman, vice chairman and head of the investment banking group at Mesirow Financial Holdings Inc., Chicago.

Existing Dell debt “would have to get downgraded. I certainly think that is a risk and a likelihood,” Mr. Golman said. “I don't think you can put all that debt on a company and not have it affect the credit quality.”

This would cause managers of investment-grade debt portfolios to sell the Dell bonds immediately. In that circumstance, one manager's loss could very well be another's opportunity. A downgrade of existing Dell debt would be very good for high-yield bond managers who could scoop up the debt on the cheap, Mr. Rosen said.

It will be a different story for investors on the equity side of the deal. Mr. Dell accounts for the lion's share of the cash and equity being used for the buyout. Silver Lake — from its private equity funds and quite possibly limited partner co-investors — is expected to invest about $1.4 billion. Only the private equity investors will have much exposure after the deal has been completed, and Dell will be private.

For private equity investors gaining exposure through the Silver Lake funds, there will be little impact. “I don't believe that the incremental exposure some funds might have as a result of being in Silver Lake will make much difference,” said Mario Giannini, CEO of alternative investment consulting firm Hamilton Lane, Bala Cynwd, Pa.

Protests by current holders of Dell stock — including T. Rowe Price Group Inc., Southeastern Asset Management and Pzena Investment Management LLC — make it clear the Dell buyout is far from a done deal. One possible outcome of the opposition is that the computer company would be sold at a higher price.

In a written statement issued Feb. 12, Brian Rogers, T. Rowe Price's chairman and CIO said, “We believe the proposed buyout does not reflect the value of Dell and we do not intend to support the offer as put forward.”

More proxy materials

On Feb. 14, Dell filed additional proxy materials with the Securities and Exchange Commission that included questions and answers concerning the Dell buyout. The document states Dell executives anticipate a stockholder meeting in June or early July.

“I think that if the buying group needs to bump up its bid, one source of equity capital will most likely be from Silver Lake's limited partners,” Mr. Fann said. “Over the past several years, Silver Lake has successfully syndicated some of their deals to their limited partners seeking co-investments.”

One way or another, both debt and private equity investors are betting on a Cinderella turnaround story and that Dell successfully changes its business model.

Driving the buyout is that Dell needs to make some changes that firm executives don't want done under the spotlight of the public markets and Wall Street, said Kevin McCarty, president of Chicago-based West Monroe Partners.

“It could be wholesale business transformation,” said Mr. McCarty, whose firm helps private equity firms with portfolio company mergers and acquisitions.

The amount of work that would need to be done to make Dell a successful business could make it a risky investment for any investor, he said.

Mr. McCarty added: “The company has to make some difficult decisions.” n

This article originally appeared in the February 18, 2013 print issue as, "What's in your portfolio? Dell debt, most likely".