Michael Dell Bought His Company Too Cheaply
bloomberg.com
bloomberg.com
Reminds me of the land taxes on the value of the property. The value of the area goes up, the house is taxed into a higher bracket because it is worth such and such. But no one will buy it for that appraisal so how can it have that value?!
Or collecting comics or coins. My comic book is valued at $1000! Great, but no one will buy it for that much. I only get $500 offers for it. Things are only worth what they are actually exchanged for.
Wouldn't this ruling mean that going forward private equity companies will pay even less for companies, building into the price that somewhere along the way they will get sued and have to pony up some more?
Interesting, though, that the courts' appraisals are trusted over the market in this case. It's sort of like an anti-crowd-dynamics protection, but only for people who vote no. Your decision over whether to vote no is influenced by your knowledge of likelihood for the total vote to succeed, as henrikschroder mentions[2].
[1]: https://news.ycombinator.com/item?id=11816921 [2]: https://news.ycombinator.com/item?id=11816784
One risk when investing in a public company is every other shareholder, and in this case a majority of the shareholders voted to agree to the buyout price. Tough cookie for the minority holders who opposed it, but why shouldn't they bend to the will of the majority? Why should they be rewarded after the fact?
The precedence seems terrible to me, because as a shareholder in a future case like this, it is clearly beneficial to accept whatever buyout offer is on the table, and the immediately class-action sue the buyer for the difference between that and some fictional "fair" price. What happens if every shareholder does this?
But then if judge's logic becomes the standard, then doesn't that mean you should always vote against the the deal if you think most people will vote for it?
It's the same reason why the government spending multiplier isn't infinite, even though government spending spurs private sector spending, and private sector spending increases the tax base.
The flaw in the logic is likely in that it de-valuates the risk associated with holding on to the shares, particularly in a short term focused market. Also, that over time business strategy and direction change. Finally if they thought the price was too low why did they sell in the first place?
If you're an existing shareholder when a company goes private, you're forced to sell at a set price. That's why it's a legal issue. That forced sale is not a free market transaction.
If you look at the history of leveraged buyouts ("private equity" is usually powered by borrowing against the company's assets, not a pure cash transaction), the existing stockholders generally lose.
I agree with the author that having a judge determine the correct price seems perverse.
I get that this isn't a democratic government where we have to guarantee full protection under the law for an individual but what I'd the 51% decides the sale price should be 1picodollar per share and then the new owner awards the 51% with shares effectively giving back their ownership? I imagine this won't happen in real life but just as a thought experiment... should it be OK?
However, according to the article the judge thought the process was fair, that there was no way to sell the company for a higher price, and shareholders voted for the deal while possessing all relevant information. I think that given those facts the deal price should be considered fair.
Boy, that's certainly a can of worms. Is someone who builds up a great company with low equity, then intentionally runs it badly to lower the share price, acquires more shares, and then runs it well again, guilty of something? Or is that just how incentives work—they felt like they needed more investment in the business before they could give their all to it?
Does the board of directors contain competent and trustworthy people? Does an activist investor wield outsize influence? Are buyout rumors circulating?
Hard to know these things, that's a big part of why index funds are so popular.
Furthermore, even a passing acquaintance with human nature should lead you to the conclusion that people will routinely claim they are being screwed even when they are not.
Normally this is in fact not the case, because the acquirer has some sort of strategic reason behind their purchase that they believe will boost the value of the asset aside from simply operating the company as it had planned on doing prior to the acquisition. For instance, Silverlake/Dell is in the process of buying EMC - Dell/Silverlake believe that strategically, a combined Dell/EMC (or "Dell Technologies") is worth more than both companies on their own - but it's Silverlake/Dell/bond holder's cash that will make this happen. Therefor it's not realistic for current EMC shareholders to simply claim the value of EMC should be higher on its own because the purchase relies on operating synergies between Dell and EMC.
The Dell buyout by Silverlake is completely different, because throughout the sales process, it was clear that Michael Dell and Silverlake were not going to do anything to alter Dell's operational plan - that is, everything that Michael Dell and Silverlake were going to do to the company while private is pretty much exactly what the plan was had Dell remained public. So the judge decided to rule that Silverlake must have valued Dell at approximately what he ruled them to be. The case would be very different if Michael Dell/Silverlake were taking the company private and making major strategic changes to its businesses (shareholders could still sue, but the line of reasoning from the judge would be different).
Can someone enlighten me here? What is the reasoning for allowing people to buy from people who don't want to sell?
(some sort of majority rule that is)
When you're forced to sell at whatever price, you lose any claim on the future price of the stock.
If a court can give you more money later, then you effectively weren't really forced to sell the stock. You retained some sort of "ghost ownership" with an entitlement attached.
Thus, effectively, the provisions of the shareholder agreement which have to do with this are disregarded.
That Dell was an insider probably complicates how to analyze this particular case.
Through one reason or another, you and I both own portions of a house. I own 95% of it, and you own 5%.
I want to sell, because I would like to have the money. You believe if we wait a year we will make more money. Is it fair that your very much minority position could prevent me from selling my much larger stake? It's a house so chances are we can't sell it piecemeal (which is unlike stock of a company, but very similar to going private as a company!)
I've been through this a few times with stocks I've held, and rarely am I happy about the outcome. For example about 10 years ago I saw something that apparently no one else on wall street saw, so I purchased a number of shares in three competing companies in proportion to how well I saw them profiting over the next 5-10 years. It wasn't 6 months later that Warren Buffet announced he was buying the company I had bet on the heaviest.
Lets just say that I'm still sore about it 10 years later. I even checked the, "I want my stock converted to BRK/A" but they ignored it, because I was going to have too small a fraction of a single share of BRK (which would have been amusing by itself). Heck, in the 10 years since BRK/A has again doubled.
So, IMHO, its just another case of the market being rigged for the big investors.
We changed our company constitution for this exact reason. We felt that it was important that the majority owner could present an empowered, decision making face to the outside world, rather than having to start any discussion with"I'm here to talk, but I need to run anything past all the other owners".
This does impact on the rights of the minority owners - a 2% owner can't hold up or influence an acquisition for example - but the upside is that their shares are worth more than if the company was controlled by a squabbling rabble.
Having gone from a majority owner to a minority one, I still feel this was the right move for us.
1. It's a statutory right, so it doesn't need to be and generally isn't covered in shareholder agreements: By law in Delaware (where Dell was incorporated) and probably most other U.S. jurisdictions, minority shareholders who don't vote for a buy-out, and don't otherwise consent to it, can't stop the buy-out from going through, but they have the right to demand a judicial appraisal of the "true" value of their shares. [0] [1]
2. Also, public companies normally don't even have shareholder agreements among all shareholders. The articles of incorporation and the bylaws are probably the closest approximation. In many jurisdictions, the board of directors can unilaterally change the bylaws without shareholder approval. (Shareholder approval is often required for changes to the articles of incorporation, though.)
[0] https://www.sec.gov/Archives/edgar/data/878280/0001193125082...
[1] http://www.jonesday.com/newsknowledge/publicationdetail.aspx...
1. You buy 51% of the shares (and voting rights), make an offer to buy the remaining 49% and call for a shareholder meeting to vote on the offer. You have the majority, vote yes, and acquire the company.
2. You acquire 90% of the shares. You don't even have to call for a shareholders vote; you can acquire the company immediately and squeeze out existing shareholders who are forced to sell and the offer price.
You can either acquire shares by submitting a tender offer (offering to buy shares at a specified price from shareholders) or tapping the public markets (and disclose it). If you think about this a bit more, you'll see there are ways to game the system by, for example, buying enough rights then making a low-ball offer but most of the loopholes are well covered by corporate law.
To address your complaint on fairness, yes, you can be forced to sell because if most of the shareholders want to take the company private, it would seem fair from the majority's standpoint to accept its rule. Not perfect but I don't think there exists a better mechanism.
Why not just allow the option to let the company go private but let these stockholders retain their minority holding? If you, like the PE firm, think the company is undervalued by at least 20-30% why can't you just retain ownership through the deal and receive your proportion of dividends?
http://www.ecfr.gov/cgi-bin/retrieveECFR?gp=&SID=8edfd12967d...
You can't simply start accumulating shares silently on the public markets and then suddenly declare one day "I own 51% shares and now all your shares are worth 1 cent each muahahah!!!"
This is absurd. If you don't wish to be outvoted in the sale of a public company, then don't buy shares in a public company. This is the deal you agreed to when you bought in. As a minority shareholder, you don't get veto power. You cannot unilaterally block a sale any more than you can unilaterally evict the board.
Nor should you be able to. As unfair as it may seem that someone else can force you to sell[1], it's just as unfair for you to be able to destroy other shareholders' value by blocking a sale.
[1] It's actually not true that you are forced to sale. Just as if you own part of a house and the other party wants to sell, you have the option to buy instead. You can pony up the cash to buy the house at market value, and your can do the same and buy the whole company. Can't afford that? Tough. You don't get to deprive other stockholders by torpedoing the same.
This means the more disturbing part is that the judge has had 3 years of hindsight where parts of Dell's plan have been realized, making it appear as though they were inevitable when at the time it was still highly uncertain (as reflected in the stock price). If Dell, Inc was now in the shitter he wouldn't be awarding $3.87 / share, that's for sure.
The baffling part to me is that he found Dell (the person) and the board conducted themselves ethically during the buyout, yet still found in favor of the plaintiffs. The rule of thumb with management-led buyouts is that the shareholders are getting screwed. If he wasn't hiding information, and wasn't strong-arming the board into approving his offer / not soliciting other offers, then the accepted offer should stand.
> This means the more disturbing part is that the judge has had 3 years of hindsight where parts of Dell's plan have been realized, making it appear as though they were inevitable when at the time it was still highly uncertain (as reflected in the stock price). If Dell, Inc was now in the shitter he wouldn't be awarding $3.87 / share, that's for sure.
That's not what the judge was ruling on, and it's not cited in his decision explaining the numbers (agree with him or not, his reasons are compelling for how he arrived at the numbers). The ruling is that at the time of the take-private, Silverlake must have valued the company at his price - the highest price - because if not, the purchase would not have offered a compelling return for a private equity investor. What's happened in the last three years did not enter the equation.
Hindsight bias is usually unconscious, so its unsurprising that it is not cited in the ruling.
Your last sentence suggests that every acquisition is a swindling of shareholders, but again, you are not taking risk into account, and perhaps the judge did not either. Most professional investors do not adequately adjust for risk, so why would I expect a judge to?
I don't know why you are trying to make this point about adjusting for risk when the entire question revolves around what the stock was worth at a stationary point in time three years ago. There is no risk basis to the calculation as discussed here - it's not a question of the judge possibly taking it into account or not, the judge absolutely did not factor it in. Whatever has happened in the world in the ensuing three years would not have affected this lawsuit either way.
That you don't see how these two are connected is my point.
Let me take a step back. The value of a company is the sum of the cash that can be taken out of the business in perpetuity discounted back to present value.
A common mistake is thinking that you can nail this down to a precise figure. In fact, it is a range of potential values. Why? Because the future is uncertain, and those future cash flows are uncertain. In other words, there is risk involved. So in the optimistic scenario where everything in the business goes right, you get a high valuation. In a pessimistic scenario the valuation is lower. Which is correct? Nobody can tell from the outset.
Now imagine you are doing a valuation for a business, but for the value of that business 3 years ago. You have had the advantage of seeing the trend those cash flows have taken the past 3 years, and whether you admit it to yourself or not, it will influence your valuation. That is all I am saying.
And what exactly are those trends? Dell has been private for three years, how the company is doing is not and has not been public since the deal closed. I see how they're connected and I understand your point in aggregate, but it's 1) not relevant in the first place and 2) even if it were, the positive economic picture you're painting isn't even apparent - Dell could be a disaster right now and nobody would know (and the judge still would have ruled similarly.)
This is untrue. Dell has released financials at least once since they went private, when they were bidding for EMC.
"Things are worth what people will pay for them" is pretty much rule #1 for valuations.
X can be a judge, a politician, etc. This is often followed by something about conspiracy or incompetence by simple selection. But still, people rarely think about what really went on in the head of the X. They just like to strawman X and reshare the narrative.
It often turns out (at least 50% of the time) that there is more to the story and X's decision process is actually reasonable given all the facts they has to deal with.
But I am impressed by why people have a tendency to ignore that.
I guess in a meta way, my own comment engaged in the same thinking to some extent, about commenters.
I will say one more thing though: the # of comments a political item gets indicates how controversial it is, while the # of shares it gets indicates how many people agree. Horizontal vs Vertical measures. Anyone write about this?
In a judicial system, the decision maker should document the facts and reasoning that were considered to arrive at the conclusion.... some of it is included in the article ....
To use your comic book example, if you own the comic book, you believe it is worth $1000, and you don't want to sell for a dime less, then it is wrong to force you to sell to someone at $700 just because nobody has yet offered you more than $500. That's theft which can be only made right by returning your comic book or by giving you the price you want.
Isn't the whole point of a buyout that you think other investor's are incorrectly valuing a venture based on the available information? If any buyout is going to be subject to this later, with-more-hindsight review that forces buyers to "top up" to the "correct" value, what's the point?
Sometimes I wonder how business manages to work at all in the presence of this "jackpot justice".
But the problem with this ruling is, that it's ridiculous - the court's argument is basically that the "fair value" is above what PE paid because PE wanted to make a profit! It basically contradicts the whole idea of the market (buying something if you think it's worth more than the current price)!
The PE firms bought the company knowing this could, and probably would, happen. It is factored into the price they are willing to pay.
You can say the same to the people buying a public company; there is an inherent risk that you will be forced to pay some shareholders more, so it should be factored in to the price you are willing to pay for the company.
I own 51% of the shares, so have a strict majority of all votes. I call a shareholder meeting and propose to take the company private by selling all the shares to me, for any price I choose. The vote passes by majority.
To prevent the 49% being completely screwed with regularity, the law provides for those who voted against such a takeover to have the sale reviewed by a judge. The 51% owner takes this into account when proposing a price.
In the case of a political election, the losing minority does not have their property instantly and compulsorily purchased at an arbitrary price set by the winner.
Interestingly, I think it capped the amount you could offer at something like 2x the current market price, their own version of imposing an "arm's length" restriction...
>In the case of a political election, the losing minority does not have their property instantly and compulsorily purchased at an arbitrary price set by the winner.
Actually, in many poorly-run democracies, they do something very close! I'm reminded of the Dilbert comic: "If you vote for me, I'll take money from the people who didn't, and give it to you!"
It's no more unusual than "forcing" naysayer shareholders to accept the dilution that comes with e.g. a secondary offering.
(Certainly, there are reasons to dispute the prudence of the decision, but that would be orthogonal to your argument, which seems to be about the mere fact of overruling minority dissenters.)
I understand government can do it for greater purpose, like building infrastructure but a company?
How can a company say "you know what, these stocks that were issued to represent ownership won't be a thing since next month, we can give you 13 bucks for each so you won't feel like a total looser"?
Suddenly I'm all for judge deciding how much people that were basically sold piece of paper with some meaningless letters should get.
What is next? Maybe I can buy Apple stock because I expect them to launch a self driving car next year, and if they then don't focus on self driving cars I can sue because it is not what I expected?
The lawyers here would have to prove that Mr. Dell was working in his own interest here, and not in the shareholders' interests.
> '...but to rule that you should offer more than the market was valuing it?'
Acquisitions in general are almost always for a premium based on the current market value of the company. Just look at Salesforce/Demandware this morning, with the stock up >50% over where it closed yesterday. As the article states, the current shareholders of the company obviously believe that the company is worth more than the current price - if they didn't, they would have sold their shares. The argument is regarding how much more it was worth, but the practice of it being worth more than it was at the time trading publicly when it comes to a buyout, take-private or acquisition is not in and of itself unusual.
> Even though no one was actually willing to pay that price?
'Nobody' is sort of subjective here. No, nobody that was involved in the take-out process was willing to pay that price. But the lawsuit was brought by shareholders, who very well could have believed that the stock was worth $50, yet had positions as large as they could manage. The judge actually ruled that his price was correct because nobody (in the sales process) would be willing to pay that amount as private equity would need a significant return on its capital (25% in this case).
> Isn't the whole point of a buyout that you think other investor's are incorrectly valuing a venture based on the available information? If any buyout is going to be subject to this later, with-more-hindsight review that forces buyers to "top up" to the "correct" value, what's the point?
The Dell case is unusual because Michael Dell did not make the case for any sort of managerial or strategic shift post-buyout (hell, why would he push for a managerial change as the CEO). Normally in the acquisition/buyout/merger/etc process, there's something materiel that the acquirer wants to change to make the company more valuable. Maybe they want to purchase the company and get rid of all the managers. Maybe they want to purchase the company and achieve cost "synergies" between two or more companies where significant savings could boost sales. Maybe they want to let both companies sell each others products. In this case, Michael Dell didn't want to do anything different from what the current plan for the company had been -- he just wanted to do it in private. So while this decision is wild, it's not one that sets precedents for most acquisitions.
In other words, sure the price might have been "wrong" but why was it necessary to rush and correct it? Won't the market do that in the long run?
The formula is the same - take a complex issue, simplify it beyond recognition, and then act outraged that the rest of the world, when considering the entire complexity of the issue, had a range of reactions different from your five-year-old view of things.
It's great entertainment for the masses, but it's a different genre from informative journalism.
But only in the footnotes does it mention this:
>To be eligible for the court-ordered price bump, investors must have voted against the transaction.
Clearly, everyone who owned Dell stock at the time thought it was worth more than $9.35. That's why they held the stock in the first place! Those who thought the company was worth much more (say, $18 per share), presumably voted against the transaction. They were understandably pissed when the transaction succeeded anyway, so they sued. But those who voted in favor of the transaction didn't get an extra penny -- they agreed on a price, and that's what they got.
On a related note, here's an interesting game theory tangent: If you think the buyout offer is a great deal, should you vote for it? After all, if you're confident the deal is going to succeed even without your votes, maybe you should vote against it -- to preserve your option to sue for even more money. But if everyone thinks like that, then the deal won't go through at all...
[S]elf-interest concentrates the mind, and people who must back their beliefs with their purses are more likely to assess the value of the judgment accurately than are people who simply seek to make an argument. Astute investors survive in competition; those who do not understand the value of assets are pushed aside. There is no similar process of natural selection among expert witnesses and [] judges
And
―The benefit of the active market for UFG as an entity that the sales process generated is that several buyers with a profit motive were able to assess these factors for themselves and to use those assessments to make bids with actual money behind them. For me (as a law-trained judge) to second-guess the price that resulted from that process involves an exercise in hubris and, at best, reasoned guess-work.
[1] http://courts.delaware.gov/Opinions/Download.aspx?id=215980
From the article (in reference to shutting down a suit against Aruba for selling too cheaply to Hewlett Packard) "It wasn’t a first for Mr. Laster, long the court’s firebrand. In his six years on the bench, he has made weeding out weak cases something of a pet issue. But “this time feels different,” said Ed Micheletti of Skadden, Arps, Slate, Meagher & Flom LLP, in part because Mr. Laster’s colleagues are joining him."
http://www.wsj.com/articles/the-judge-who-shoots-down-merger...
It seems that in this case he felt that the price discovery mechanism of the process and go-shop wasn't sufficient to reach the theoretically "correct" price, which makes sense. The reason any market approaches efficiency is because investors can easily buy and sell undervalued or overvalued securities. In massive transactions of this sort, there are only a handful of buyers who can participate, and it would be unreasonable for such a situation to be as efficient in price discovery as a liquid, publicly traded market.
My sense is that the issue is more with the law, and ability to challenge this sort of thing (which is mostly capitalized on by specialized hedge funds who buy shares and sue) holds a transaction to a different standard than when it actually occurred. Specifically - the board, representing the fiduciary interests of shareholders, should be expected to make a reasonable effort to get the best price. If markets are not efficient and no one has the capital to step up and make a purchase, how would they know that? You can never prove the counterfactual in that type of situation, and it seems dangerous to attempt to do so via ex-ante analytical modeling.[1]
1. I get that this concept is widespread in settlements of all sorts (loss of use, damages, etc.), but in this case, no one was defrauded or coerced. Shareholder agreements were obeyed, and that should be that.
Most of the vehemence is in regards to privately held companies which can't directly be shorted. In fact, that may actually contribute to the odds of the company being overvalued.
> is definitely overvalued at $80B"
Going long is safer, but can still be bad. If the price drops below your buy-in, and a merger is agreed at the low price, you can be forced to sell low. You could have bought into Dell, and then been forced to sell lower than your own valuation.
If you think the market is over-valuing a stock you hold, you sell it. If you think it's worth more, then you keep it, and refuse any offers to purchase it for less than you think it's worth.
These people tried to refuse the offer. As mentioned in the footnotes, only those who voted against the deal were entitled to sue for compensation.
The tricky thing is that shareholder voters exhibit very weird and irrational behavior (due to proxies, lobbying, the T Rowe Price craziness, etc.), so I'm not sure game theory is terribly useful to begin with here.
My scenario is that I vote "no" even though I think selling is the right decision. I feel I can do this because I recognize my vote will likely not prevent the outcome I want, and it insulates me against the risk that I, and others, are wrong.
Has this happened with other buyouts or mergers? I thought the point of the share price was to show what investors were willing to pay. To assume every buyout is purposefully under cutting the price by 25% will just depress future offers
Of course, having a judge decide is silly, too.
"The efficient markets hypothesis" is not precisely the same as "consumer surplus". The EMH is dependent on consumer surplus, but the EMH could be wrong and consumer surplus would still not be.
Consumer surplus is a microeconomics concept; the EMH is macro.
This error isn't critical to the rest of the article, but it's jarring to see something like that in the first few paragraphs.
But when both parties want "the thing that throws off the most money", it's a lot harder to come up with a scenario in which (reflectively consistent) preference sets allow for a range of possible sale/purchase values.
IOW, it's fine for a worker to be (hypothetically) willing to take a lower-than-market value for their labor ... but if a financial seller is, then there's (probably) a misvaluation somewhere, and thus an EMH violation.
The only reason I ... tolerate markets ( and I tolerate them quite well ) is that they act as a price discovery mechanism, a way of constructing decision trees using dynamic information. I have enough bandwidth to understand that basic trade - someone selling vegetables on the side of the road - is a win-win. Beyond that? I dunno. Hypothetically, Bob and Alice are specialized to each widget, which makes them more efficient.
If we cannot come up with a preference-relation in which a range of possible sale/purchase values is allowed, then we can't really even hoist consumer surplus into use to support the EMH, can we? Isn't it at its core now a phony, game-playing exercise? There's no there there; it's curve-fitting nonsense on stilts at best.
Self-referential systems are known to be deep pools of unmanageable complexity. And M&A seems to be a widely ignored disaster.
I suspect - but really lack the chops to prove - that Adam Smith had it right all along, but that humans will always revert to isolated pools of mercantilist rent-seeking. That "markets" require beings who do not exist, or who have managed to get just enough ethical boilerplate to avoid the rent seeking. Just as Progressivism requires philosopher kings, so do ( apparently ) markets. So we're down to "well, it keeps the people who might otherwise be violent busy."
When asked about American democracy, Ghandi said "I think it would be a good idea." I think capitalism would be just such a good idea.
ObDisclosure: I have an old Usenet contact who is quite wealthy from a hedge fund. This guy's a PhD in applied math. He reports "I refute the EMH thusly" by kicking the logo of his firm.
Is the footnote for that line, so I think the EMH thing is a joke.
Disregard that note, and sue Bloomberg and the writer anyway. Seems to work, according to the text.