Author Topic: DVMT - VMW Tracking Stock  (Read 19035 times)

johnhuber

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DVMT - VMW Tracking Stock
« on: September 06, 2016, 08:53:36 AM »
I didn't see a thread on this, so I thought I'd start one. I'd be interested if anyone has looked at the VMW tracking stock, which will be issued to EMC shareholders by Dell.

Quick background: Dell is buying EMC for $24.05 per share in cash and .111 share of a tracking stock. The tracking stock is issued by Dell (the company is now called Denali, but I'll refer to it as Dell). So the tracker is Class V common stock of Dell. Each Class V share tracks one Class A share of VMware common (the publicly traded VMW). The deal closes tomorrow. The tracking stock will have a ticker DVMT, but has been trading in the when-issued market under DVMTV. Dell's use of the tracking stock allows it to avoid a big tax bill that would come from the sale of a portion of the VMW stake (EMC paid $630m for a stake in VMW that is now worth around $23 billion). The tracking stock helped Dell get the deal done without having to come up with more cash.

The tracking stock (at around $44) currently trades at around a 40% discount to VMW (at around $73 per share). A discount is certainly warranted, in part for the following reasons:

1. The tracker is Dell common stock, which means it sits behind a mountain of debt. Should Dell/EMC go bankrupt, the tracker is worthless.
2. Dell has said its top priority is to pay down debt and achieve investment grade ratings, so the tracker is currently on Dell's back burner.
3. Dell will take over EMC's 81% stake in VMW, but for tax reasons, it is unlikely that Dell will spin/sell VMW (which also means it won't collapse the tracker back into the common) for five years. So I think part of the discount is due to the fact that there is no near-term path to closing that spread

I think those are the three main reasons for the discount. There could also be a larger than expected spread because of fears that Michael Dell might act in his best interests at the expense of VMW shareholders (or Class V tracker holders). One argument is that he lets VMW struggle in order to buy the rest of it cheaper (I find this argument ridiculous though). But nevertheless, he got criticized for "taking under" Dell back in 2013, and that could have something to do with the discount.

So those are a few main reasons why I think the tracker trades at a discount (in addition to other reasons why trackers always trade at slight discounts: no voting rights, no legal claim to assets, etc...). Again, there deserves to be a discount.

40% discount just seems to be too much.

There are a few reasons why I think the discount could close:

1. Dell's debt facilities will allow the company to buy back up to $3 billion worth of tracking shares, which at today's price, is equal to around 30% of the 223 million tracking shares outstanding
2. VMW has a $1.2 billion buyback authorization for its Class A shares, which they intend to complete by the end of the year. This is equal to around 20% of the float (there are about 423 million VMW shares; 343m are owned by EMC, 80m are owned by public shareholders)
3. The tracking stock becomes listed on the NYSE (I'm unsure how much appetite/ability institutions have to own tracking shares, but for an investor interested in VMW at a sizable discount, this would be one way to own it).

I haven't bought the tracker because I'm still considering my thoughts on VMW.

VMW provides software that allows for more efficient use of data centers. This process is referred to as server virtualization, and VMW has a large market share. Basically, an administrator can use VMW software to divide a physical server into separate ďvirtual serversĒ, which allows a company to be more efficient with the IT infrastructure that it currently operates.

VMW makes money by licensing its software, and it also collects revenue from software maintenance and related services. VMW has a nice competitive position in its market because companies donít want to switch software providers due to the significant inconvenience associated with learning a new system as well as the downtime associated with switching.

It's also a cash cow. It will do over $2 billion in operating cash flow this year, and has around $12 per share in net cash (net of taxes). So this makes the $43 tracking price attractive. But the industry is obviously going through major changes.

Two risks to the company:
1.   A shift from on-premises data centers to the cloud. VMW could lose current customers as more and more companies shift their data centers to the public cloud, and thereby eliminating the need for VMWís product.

2.   Competition for smaller, new customers. Although VMW has an entrenched market position providing software for physical servers, Microsoft has a competitive product that is gaining traction with smaller companies, especially those who might also use Azure, Microsoftís cloud storage offering.

There have been a number of potential VMware "killers" that haven't materialized for one reason or another. VMwares prices are very high, and there are open source server virtualization products available for free, but surprisingly, VMware continues to dominate. Part of it is the support, but there are support options out there for 10% of the cost that VMware charges. I don't know the industry that well. Are there reasons why IT departments stick with VMware over what appears (to me at least) to be numerous other (much cheaper) alternatives?

This isn't a comprehensive view of VMW (because I don't really have one), but just some thoughts I've cobbled together from reading about it.

I think Dell is an interesting guy, and I think the situation is interesting. The bears liken this Dell/EMC deal to the famous analogy of two garbage trucks colliding (which is how people referred to the HP/Compaq merger in 2001). I think Dell (the guy) is much smarter than HP/Compaq mgmt teams though. He also has a lot riding on this.

I'm open to thoughts on Dell/EMC business as well as the VMW business (and future prospects). Anyone have thoughts on the businesses (or the tracker)?

I manage separate accounts for clients: www.sabercapitalmgt.com.
I talk about investing at www.basehitinvesting.com.


wellmont

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Re: DVMT - VMW Tracking Stock
« Reply #1 on: September 06, 2016, 10:59:22 AM »
are you sure the tracker is "dell common stock"? from my reading it seems to be a stock that tracks their holdings in vm ware...

Upon the completion of the merger, EMC shareholders will receive shares of Class V Common Stock that will be publicly traded and that are intended to track, in the aggregate, an approximately 53% economic interest in the VMware business (assuming no change to the percentage economic interest of EMC in the VMware business prior to the completion of the merger and that EMC shareholders either are not entitled to or do not properly exercise appraisal rights).

johnhuber

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Re: DVMT - VMW Tracking Stock
« Reply #2 on: September 06, 2016, 11:01:34 AM »
are you sure the tracker is "dell common stock"? from my reading it seems to be a stock that tracks their holdings in vm ware...

Upon the completion of the merger, EMC shareholders will receive shares of Class V Common Stock that will be publicly traded and that are intended to track, in the aggregate, an approximately 53% economic interest in the VMware business (assuming no change to the percentage economic interest of EMC in the VMware business prior to the completion of the merger and that EMC shareholders either are not entitled to or do not properly exercise appraisal rights).

Yes, it's Dell common stock (meaning, that Dell issues the stock). The Class V common stock (aka the tracking stock) will track 65% of Dell's (formerly EMC's) stake in VMW.

So yes, it tracks VMW (one share of tracker tracks one share of VMW), and yes, it's technically Dell common stock. Confusing, I know...
I manage separate accounts for clients: www.sabercapitalmgt.com.
I talk about investing at www.basehitinvesting.com.

wellmont

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Re: DVMT - VMW Tracking Stock
« Reply #3 on: September 06, 2016, 11:06:52 AM »
i am still confused. i think calling it dell common stock is a bit confusing if not misleading. if it were really dell common stock (a stock that would benefit if denali did well) I would be buying it right now. so it's still confusing and that may just be me. but I don't think it's that, is it? it's tracking an asset of denali right? are you sure it would be worthless if dell filed bk? what if they converted it to a c-corp stock prior to filing? it would then be vmware stock no?

johnhuber

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Re: DVMT - VMW Tracking Stock
« Reply #4 on: September 06, 2016, 12:43:31 PM »
i am still confused. i think calling it dell common stock is a bit confusing if not misleading. if it were really dell common stock (a stock that would benefit if denali did well) I would be buying it right now. so it's still confusing and that may just be me. but I don't think it's that, is it? it's tracking an asset of denali right? are you sure it would be worthless if dell filed bk? what if they converted it to a c-corp stock prior to filing? it would then be vmware stock no?

It is confusing, but not misleading. And it is Dell common stock. (Just a quick joke from Seinfeld: Kramer: "So you're saying she's deaf?" Jerry: "I'm not saying she's deaf. She's deaf".)

So it is Dell Class V common stock. This Class V common stock tracks 65% of Dell's stake in VMW.

I'm not sure it would be worthless if Dell filed for bankruptcy, but pretty sure. I am 100% sure it sits behind a mountain of debt in Denali's capital structure.

Hope that helps.
I manage separate accounts for clients: www.sabercapitalmgt.com.
I talk about investing at www.basehitinvesting.com.

whiterose

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netnet

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Re: DVMT - VMW Tracking Stock
« Reply #6 on: September 06, 2016, 02:31:23 PM »
I saw this in Barrons over the weekend as well. 

It seems to me that if it's available, shorting VMW and buying DVMW would be the way to go.

wellmont

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Re: DVMT - VMW Tracking Stock
« Reply #7 on: September 06, 2016, 03:04:47 PM »
what happens to this tracking stock if denali goes bankrupt but vmware doubles it's earnings? if the tracking stock is tracking dell's economic interest in vmware how could it be worth zero? this is what msd does. he creates "heads I win tails you lose" scenarios designed to benefit him and a small group of closely affiliated investors.

the tracking stock is intended to track the performance of a portion of Denaliís post-closing economic interest in the VMware business."


this tracking stock is nothing more than the gimmicky creation of dell, msd capital, or their bankers, designed to sell at a massive discount giving them an opportunity to buy more vmware if they so please. to me it looks like denali sees the tracker as = to vmware common for all intents and purposes.


Does Denali intend to repurchase Class V Common Stock after completion of the
acquisition of EMC?
Denali believes that having the Dell business affiliated with the EMC federation is likely to create
significant synergies and other opportunities for the VMware business and that the VMware business
is currently an attractive long-term investment opportunity.  Accordingly, following the closing of
the merger Denali may look for opportunities to repurchase shares of Class V Common Stock or of
VMware common stock.
Any such repurchases will be subject to Denaliís ability to generate free
cash flow (through operations, assets sales or otherwise), to Denaliís objective of paying down debt
in the first 18-24 months after closing and achieving an investment grade rating, to restrictions in
Denaliís debt instruments, to market conditions and other factors.  Dellís debt facilities are expected
to include a $3 billion basket permitting such repurchases and other types of restricted payments,
which basket may increase over time based on Dellís net income and other factors.
« Last Edit: September 06, 2016, 03:30:16 PM by wellmont »

netnet

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Re: DVMT - VMW Tracking Stock
« Reply #8 on: September 06, 2016, 03:34:56 PM »
what happens to this tracking stock if denali goes bankrupt but vmware doubles it's earnings? if the tracking stock is tracking dell's economic interest in vmware how could it be worth zero?

It could be worth zero for the same reason that the "regular" common could be worth zero, it is junior to the debt and is fundamentally a part of Denali's capital structure NOT VMWare's. it gives the equity holders a junior interest in Denali's equity in VMWare, if that equity is gone then you have a stock that tracks goose eggs, i.e. 0's!

wellmont

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Re: DVMT - VMW Tracking Stock
« Reply #9 on: September 06, 2016, 03:43:17 PM »
what happens to this tracking stock if denali goes bankrupt but vmware doubles it's earnings? if the tracking stock is tracking dell's economic interest in vmware how could it be worth zero?

It could be worth zero for the same reason that the "regular" common could be worth zero, it is junior to the debt and is fundamentally a part of Denali's capital structure NOT VMWare's. it gives the equity holders a junior interest in Denali's equity in VMWare, if that equity is gone then you have a stock that tracks goose eggs, i.e. 0's!

the public vmware common is not owned by denali. it would not be worth zero in Denali bk. denali does not own 100% of vmware. it would be worth what vmware is worth. again if vmware doubles it's earnings and the tracking stock is tracking that performance of vmaware how could it be a zero if dell goes bk? in my mind it shouldn't. if it could that is a disaster for owners of this tracker. imagine owning a stock that tracks the performance of a company that doubles its earnings over your holding period but you end up with ZERO.
« Last Edit: September 06, 2016, 03:44:53 PM by wellmont »