January 23, 2013 8:23 pm

Dell bondholders: nervous times

Any buyout deal likely to lead to net debt and riskier securities

Bondholders hate LBOs. Why? They wind up holding junk bonds that pay investment-grade interest rates. How? A private equity firm buys out the public shareholders at a premium, using heaps of borrowed money. The risk profile of the company spikes, new senior bonds are issued, and the old bonds plummet. Of course, if all goes well, bondholders are ultimately repaid. But in the meantime, though, they are stuck with riskier securities.

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Dell’s bonds have plunged even as its stock rallied 20 per cent on the prospects of a buyout. Any deal will have lots of moving parts. Dell could repatriate some of its $11bn in cash to support the buyout, Michael Dell could contribute new funds on top of his current $3.8bn equity stake, and Microsoft may get in, too. But the numbers could look something like this: $14-a-share deal would run to $24bn. If $8bn of the computer maker’s cash was repatriated, that would cut the bill by more than $5bn, after taxes. Assuming the sponsors (and Mr Dell) come up with about $6bn in equity financing, about $13bn incremental debt would be needed (in addition to any refinancing of the old debt). Dell would go from having net cash to having net debt of more than 3.5 times earnings before interest, taxes, depreciation and amortisation. Cue multi-notch downgrades.

A Dell deal would not reopen the market to new mega-buyouts. Mr Dell’s role significantly reduces the amount other sponsors need to pony up, making this a special case. That is good news for yield-starved investors who poured more than $100bn into investment-grade bond funds in 2012, according to Lipper. Nonetheless, that a deal this size can even be considered marks a change in attitudes towards risk. As the crisis recedes, companies are growing less concerned about building fortress balance sheets and more inclined to take on leverage to boost returns. Bondholders have every reason to be jumpy about this shift.

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