Dell-EMC Merger Gets FTC Approval, Remains On Track To Close

IT behemoth Dell and data storage giant EMC (NYSE:EMC) announced this week that the waiting period for U.S. antitrust regulations regarding the proposed Dell-EMC merger had expired. ^[1] In addition to the U.S. FTC, both parties are on course to get the required EU approval at the end of the month. ^[2] Moreover, Chinese authorities are also likely to approve the merger despite the possible impact it might have on Huawei, the current market leader in the data storage space in China. ^[3] With this regulatory hurdle crossed, Dell can now proceed with the merger pending approval from EMC shareholders.

We have a $28 price estimate for EMC, which is slightly higher than the current market price. EMC’s stock price has fluctuated between $24 and $28 since the Dell-EMC proposed merger was announced in mid-October last year. On the other hand, EMC-owned VMware (NYSE:VMW) has witnessed a 40% drop in its stock price since the deal was announced.

See our full analysis for EMC’s stock

The Merger: Backdrop & Future

EMC had faced pressure from some of its large institutional investors since mid-2014 to spin off some of the fastest-growing businesses within the company such as VMware and Pivotal. ^[4] Prominent activist investor Elliott Management constantly pushed EMC’s management for structural changes to aid shareholders. ^[5] EMC’s management was keen to operate its “federation” business model at the time, wherein some acquired companies operate as separate entities, while they still collaborate on products for large clients.

Subsequently, the Dell-EMC merger was announced in October of last year with Elliott Management supporting the merger. ^[6] Over the last few months, the U.S. Federal Trade Commission imposed a review period based on the Hart-Scott-Rodino Antitrust Improvements Act of 1976, under which the involved parties under can not take any steps to integrate or merge their operations, or obtain operational control of the acquired party. ^[7] This waiting period expired on February 22, after which the companies can begin merging operations. The combined entity will now be in a position to offer integrated compute and storage product offerings across Dell’s global sales channel. The merger is expected to close by the fall, pending approval from EMC and VMware shareholders. ^[8] EMC’s “federation model” can now scale up to include Dell’s enterprise products along with products and services to big customers with integrated offerings from VMware and Pivotal.

Acquiring EMC’s data storage and related businesses makes sense for Dell to help it compete directly with HP and IBM (NYSE:IBM). EMC is a clear leader in the storage systems market, commanding a nearly 30% market share in worldwide factory sales of external storage systems, which Dell can add to its 6-7% share in the market. Comparatively, IBM and HP hold 10-11% share in the external disk storage systems market. Moreover, Dell can now offer integrated IT offerings to enterprise clients with EMC’s data storage, content management, data security and cloud foundry offerings under its belt.

Why Is VMware’s Stock Suffering?

Under the conditions of the deal, Dell will continue to keep VMware as a publicly traded company. For each EMC share, shareholders will receive $24 in cash and about 0.111 shares of VMware’s new tracking stock (note: VMware’s stock was trading around $78-82 in mid-October). As a result, the total combined purchase price stands at just over $33 per EMC share, taking the total value to $67 billion. ^[9] Dell will add almost $50 billion in debt to go through with the acquisition.

Before the announcement was made, EMC had an 80% stake in VMware and 97% of voting rights. With Dell acquiring EMC, it has effectively taken the 97% voting rights but floated over 50% of VMware’s stock as tracking stock with no voting rights. After the merger is completed, Dell will have a 28% stake in VMware with 97% voting rights, while existing VMware shareholders will retain the 20% ownership with 3% voting rights, and over 50% ownership lies with former EMC shareholders in the form of tracking stock with no voting rights. ^[10]

Not only has the introduction of the tracking stock increased VMware’s float and depressed the valuation, shareholders are bound to be unhappy in a scenario where 97% of the voting rights lie with a party that has only a 28% economic interest in the company. However, VMware’s long-term growth prospects are likely to be unaffected by its parent company being acquired by Dell. VMware has a strong global customer base with market leading positions in key market domains including server virtualization, software-defined networking and hybrid cloud computing. As the company evolves from primarily an on-premise virtualization service provider to a cloud computing vendor, it could continue to capture a significant portion of the addressable market. With the fast-growing divisions expected to continue to boost top line figures for VMware in the coming quarters, we believe that the company is poised to capitalize on the shifting market trends. Consequently, management believes that Dell and VMware could generate more than $1 billion in cost synergies over the next few years. ^[11]

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1. Dell and EMC Receive U.S. Federal Trade Commission Clearance for Proposed Merger, EMC Press Release, February 2015 [↩]
2. Exclusive: EU set to clear Dell’s $67 billion deal to buy EMC, Reuters, February 2016 [↩]
3. What Dell’s Deal for EMC Means for China Tech, Wall Street Journal, October 2015 [↩]
4. At EMC, Marriage Requires Investment, Wall Street Journal, July 2014 [↩]
5. Hedge fund Elliott pushes EMC to split off VMware: WSJ, Reuters, July 2014 [↩]
6. Elliott Management Comments on EMC / Dell Transaction, Market Watch, October 2015 [↩]
7. DOJ Brings “Gun Jumping” Enforcement Action and Requires Disgorgement, Transaction Advisors, December 2014 [↩]
8. Dell Can Buy Out EMC, Say U.S. Antitrust Regulators, Re/Code, February 2016 [↩]
9. Michael Dell, MSD Partners, Silver Lake Lead Transaction to Combine Dell and EMC, EMC Press Release, October 2015 [↩]
10. Dell Will Issue a Lot of Not-Quite-Stock to Pay for EMC, Bloomberg View, October 2015 [↩]
11. Why Dell’s EMC Bid Leaves VMware Looking Like Devalued Currency, Wall Street Journal, October 2015 [↩]