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Dell and VMware hammer out deal, but no reverse merger

Dell and VMware have taken a step – maybe only the first step – on a journey to fund Michael Dell’s on-again, off-again love affair with going public.

Dell Technologies, parent company of storage giant Dell EMC, is preparing a return to the public markets, fueled by a $9 billion recapitalization from its VMware subsidiary. The vendor disclosed its plans Monday following months of deliberation by Dell’s board and special committees.

Dell will eliminate the VMware tracking stock (DVMT) created as a result of the Dell-EMC merger in 2016. Dell plans to list a new class of common stock directly on the New York Stock Exchange. The arrangement allows Dell to go public without filing for an initial public offering.

As a result, Dell would assume direct management control over VMware, which could prove to be a preliminary to a future Dell and VMware merger.

Recent U.S. tax reform provided “excess balance-sheet cash” that aided negotiations between Dell and VMware, Dell executives told investors on a conference call this morning. The deal is expected to close in the fourth quarter, pending approval of VMware shareholders.

Dell CEO Michael Dell said no changes are anticipated to the company’s operating groups, which span networking, servers, software and storage.

“The simple answer is we don’t anticipate any changes.  I think if you look at the last five years, we’ve been consistently investing for growth and it’s been working.  We’ve had steady, strong share gains across our businesses.  And we intend to continue to do that,” Dell said.

Dell’s reentry to the public markets comes five years after Dell left it to avoid the scrutiny of Wall Street. The $24.5 billion buyout in 2013 was engineered by equity firm Silver Lake Partners, which also was instrumental in financing Dell’s acquisition of EMC, including a controlling interest in VMware.

Dell finalized a $60 billion-plus merger with EMC in 2016. During the April quarter, the Dell EMC storage business posted positive growth for the first time since the deal was finalized, generating $4.1 billion, up 10%. Consolidated Dell revenues topped $21.5 billion, up 17% year over year.

Patrick Moorhead, a principal analyst at Moor Insights and Strategy in Austin, Texas, said going private positioned Dell to acquire EMC and expand its reach in enterprise storage and virtualization.

“Dell’s timing on going public again is interesting, coming so soon after it brought the storage business back to growth. Dell has been saying that it was gaining market share, but the storage (revenue) had been flat until last quarter. That leads you to believe they would have to be pretty comfortable that the storage will continue to grow as a public company,” Moorhead said.

Craig Lowery, a research director in Gartner’s technology and service provider group, said customers are shifting to the public cloud and away from on-premises enterprise hardware. He said that trend almost certainly influenced Dell and VMware to make the move.

“Consumption of IT is going up across the board, so all boats are being lifted by that tide. It’s a little harder to figure out how to use it than they thought, but our research shows that customers are moving toward public cloud.  The time for Dell to do this deal was now. Any longer and they would look less and less viable,” Lowery said.

As proposed, holders of VMware tracking stock can elect to receive $109 in cash per share, or have their shares converted to Dell common stock. The cash portion of the deal is capped at $9 billion.  The cash consideration of $109 per share represents a 29% premium to the closing share price immediately prior to the announcement, Dell officials said.

A special committee of VMware’s directors has approved an $11 billion cash dividend. Under the proposal, Dell Technologies would receive approximately $9 billion to pay the VMware shareholders and apply remaining proceeds toward debt or share repurchases.

Talks of a reverse merger between Dell and VMware have percolated since last year, but those discussions reportedly hit a snag when VMware directors resisted the idea. VMware will remain an independent subsidiary with a separate balance sheet. Dell will retain an 81% ownership stake.

“A reverse merger would have been disastrous for VMware partners (by making Dell a competing OEM). It would have given Michael Dell a lot of control. There is no illusion about VMware (being) a lapdog for Dell, but at least with this type of deal, VMware has enough autonomy to serve its other partners objectively,” Lowery said.

Under the proposal by Dell and VMware, Silver Lake Partners will maintain its 24% ownership stake in Dell common stock. Michael Dell owns 72%.

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