Dell's Proxy Materials: Deal or No Deal?

For those who want to add to future global warming by killing lots of trees, Dell has issued hundreds of pages of proxy materials, including the background and timing of board discussions from the earliest days of going private to the opinions of JP Morgan, Evercore, and Goldman Sachs regarding alternative transactions.

Without doing a close reading of the materials with my  Eberhard Faber No. 2 Blackwings, here's what I put into my notebook.

The advisors agree that the issues for Dell going forward as a public company in the status quo mode include,

1. The medium-long term growth of the PC market will be challenging, with low unit growth and lower margin sales driving gross margin downward by historical standards.  This would contrast with Dell's historical strength in sales of higher margin machines, driven by its premium name and efficient manufacturing structure. 
2. The company has yet to demonstrate an ability to penetrate the tablet and smartphone markets.
3. Dell has yet to leverage the more than $13 billion of recent acquisitions into a "compelling enterprise stack."  Of course, this is the peer sector where the higher valuations reside for a "new" Dell. 
4. Can the company make the difficult, long and expensive transition from an equipment-based sales force to an Enterprise-based solutions sales force?  This is a critical question, which almost certainly accounts for the issue in point (3).  
5. By all measures, Dell's stock performance has been abysmal, and it has almost no goodwill with equity shareholders, even with "deep value" investors. Over the past five years, Dell's stock performance was (47.6%).  HPQ was even worse at (64.1%).  Dell's PC-heavy peers were down (11.2%) as a group, excluding HPQ.  Dell's Enterprise peers were up 34.7% over the five year period.  

Put all this together, and it could make a case for taking the company private, depending on the near-term outlook for Dell as it exists today.  Well, guess what?  The near-term outlook is dismal.  Surprise, surprise!

In the earliest version of FY14, management's internal plan presented to the board,  projected revenue of $59.9 billion, with non-GAAP gross margin of $13.6 billion, and non-GAAP operating income of $4.1 billion.  The board eventually realized that this was a "pie in the sky" plan, and after a downward revision that was still not convincing, management was directed to work with board member Shantaru Narayen, the CEO of Adobe, to come up with a FY14 plan in which the board and management could be confident. 

The final FY14 plan had projected revenue of $56.5 billion, about a 6% reduction from the prior plan. Gross margin was reduced to $12.5 billion, an 8% reduction better reflecting the pressures on the PC business.  Finally, a 27% reduction in projected non-GAAP operating income to $3 billion became the latest benchmark. 

Ironically, the genesis for taking the company private was a friendly approach from Southeastern Asset Management, which was kind enough to present its spreadsheets to CEO Michael Dell. For whatever reason, SAM was never a part of the MD-SLP transaction.  Now, fast forward to evaluations of various alternatives to shareholder value creation.

JP Morgan's slides do consider a leveraged recapitalization alongside an alternative for a special dividend payment to shareholders in conjunction with going private.  The leveraged recap is said to have certain benefits for supporting the share price and perhaps being EPS accretive in the short-term; the obvious drawback, not unique to the recap, is the pressure on uncertain cash flows, given the continuous weakening in the near-term projected results.  It doesn't appear that the leveraged recap as contemplated by SAM gets the same level of consideration as does the MD-SLP plan at the given price.  

It is clear that the executive suite in a private Dell should be cleared of the executives who occupy it now, as they haven't been delivering and they are probably not suited to where the company would have to go in the future.  There are questions about Michael Dell himself: he made the $13 billion in acquisitions and allowed them to flounder.  

"Go Shop" procedures, according to Evercore's slides, produced a 6% median increase over the initial announced transaction price in larger deals.  This is a benchmark that could be met. 

It's pretty easy to see a scenario where the board could accept the MD-SLP deal at a 6% or so higher consideration.  The other players, at this point, might be out in the cold in this very cynical process.  

Dell's Process: Go Shop or Store Closed?

There seems to be a distinct lack of buzz surrounding the Dell board's go shop process for the company. Here are some of the more puzzling developments.  First, as Fortune reports,

"Sources close to the situation say that Blackstone (BX) repeatedly requested the concession, threatening to otherwise walk away from the table during the "go-shop" process. Dell's (DELL) special committee eventually favored the move, believing that it would increase the odds of getting a superior offer."

The concession is that Dell would reimburse Blackstone for its due diligence costs, regardless of whether or not Blackstone were to make a serious, formal bid.  This makes no sense from the perspective of the current shareholders.

Also, Dell's former executive leader of mergers and acquisitions, Dave Johnson, moved to Blackstone in January 2013.   Among other acquisitions, he was responsible for the decision to acquire storage company Compellent and Quest Software, among others. If anyone knows where the bodies are buried and if anyone can do surgical due diligence on Dell, it should be Blackstone under Johnson's direction.

If Carl Icahn is not getting his due diligence fees reimbursed, and he hadn't even requested such a thing, then why on earth would the Dell board succumb to Blackstone's rather brazen ploy?

Southeastern Asset Management, apart from a puff piece in the New York Times about one of its founders, has been very quiet.

Finally, none of the rumors about who might run Dell in the future are comforting.  First is the rumor that founder Michael Dell would remain as CEO under a combined Blackstone/Icahn bid.  But, since the founder returned to spend billions in acquisitions and failed to energize the company's results since his return, is this a variation of the Jerry Yang story?  New money, new ideas and new management usually come together.

Finally, there is a rumor that HP/Oracle exec Mark Hurd would come to run the new Dell.  Now there's a scary thought for new investors.

Could it be that even with a peek under the covers, folks are trying to figure out a face saving exit for all concerned?

Cargill's 2012 Report: Thinking About Food.

Cargill's 2012 revenues of $133.9 billion increased by 12% over the prior year. Earnings from continuing operations were $1.17 billion, down 56% from the 2011 record level of $2.69 billion.  Cash flow from operations in 2012 was $3.51 billion.  The company deployed $4 billion in capital, including $2 billion to acquire Provimi, an animal nutrition company.

Despite the sharp drop in earnings, one third of their businesses exceeded the prior year's results.  The Food Ingredients business, comprising 26 business units, produced record earnings in 2012.  Among other 2012 record-setting businesses:

• Brazil--grains, oil seeds, cocoa and foods
• North America--corn milling
• Trade finance
• Specialty canola oils and industrial oils.

So, where did things go badly wrong?  Cargill's agricultural supply chain results were well below the prior year, as the CEO noted the trading giant "misread markets."  Cargill has operations in 65 countries, of which two-thirds are classified as "emerging market economies."  

One of the hot topics at forums on global food issues is that of food security.  The big question is "Can the world feed itself?"  Cargill's CEO noted in a 2012 presentation, "It's demonstrably true that the power of the currently existing technology--without the need to invent new technologies--will allow us to use existing water and soil to feed the anticipated 9 billion people expected to inhabit the planet by 2050."  This view is not out of the mainstream, and it's certainly encouraging, as it should allay the neo-Malthusian concerns expressed by professional alarmists.  

Cargill uses the numéraire of calories to measure the output of world food production, and it is certainly convenient.  While the total supply of calories produced is adequate to satisfy demand, there are surplus and deficit areas, as the theory of comparative advantage would suggest. World trade in agricultural products and foodstuffs should reallocate the supplies to satisfy demand.

Unfortunately, some 85% of global agricultural output is consumed where it is grown, and only 15% enters the world trading system.  So, part of Cargill's "essential work" is described as trading and logistics that connects surplus calorie areas with deficit calorie areas. Some of the trading vehicles, such as management of agricultural pools in Australia provide a flexible menu of options for grain farmers.  

Of the 15% of global output that is traded--such as corn, wheat, soybeans (whole, milled, and oil), rapeseed oil, cocoa, sugar, coffee, rice---Cargill's largest share of any particular commodity is said to be 25% or less.  

Price volatility shows up only in the traded commodity sector, as governments manipulate their own stocks in order to keep local food prices stable for political reasons.  Recent periods of higher price volatility have been laid at the feet of corporate commodity traders.  These arguments are unconvincing and unreasonable.  So what else is going on? 

Biofuel mandates in the United States are certainly a factor, as forty percent of our corn production is absorbed by ethanol as a result of non-market, Federal mandates.  All this for food which goes into the fuel tanks of our SUVs.  Also, ethanol has a marginal, if any, benefit to net GHG reduction.  So, in the words of Cargill CEO Page,

 "If we have the demand for 40 percent of our food production as completely inflexible (because of government mandates) then movements in supply..are going to have an outsized impact on price.  Today, 2 and 3 percent changes in supply are causing 40 percent changes in price, and much of that volatility is caused by the inelasticity in some portions of the mandated demand." 

A second factor is a global transportation, distribution and storage infrastructure which contributes to delays, higher costs, and significant crop spoilage. In the U.S., our inland waterways, including canals and river locks, have been neglected for decades and slow the movement of goods along major arteries like the Mississippi River.

Even in poster child success stories like Brazil, the picture isn't rosy for realizing its agricultural potential.  As a recent Bloomberg story points out,

"However, some problems may take years to sort out. The growth of the past decade has left Brazil's infrastructure straining to keep up, and cash crops often rot while trucks wait in lines to get into overcrowded ports. Companies struggle to find qualified workers due to poor quality schools." 

So despite Cargill's 2012 success in moving certain Brazilian commodities, Brazil itself lost potential export or consumption volumes to infrastructure inefficiencies that cannot be cured in the short term due to the inability to finance significant investments.   Today, paradoxically, the US imports corn from Brazil because of our own ill-conceived ethanol mandates.

According to Robert Zoellick, the President of the World Bank,

"First, we need to increase food productivity and production in developing countries, especially in sub-Saharan Africa and with smallholder farmers. To do so, we need to fix problems all along the value chain, including property rights, research and development for seeds and inputs, irrigation, fertilizer, agricultural extension, credit, rural infrastructure, storage and connection to markets."

Writing on the issue of food security, Roz Naylor, of Stanford's Center on Food Security and the Environment, notes,

"The third and much more difficult issue is the lack of political stability that would enable markets to work efficiently so food producers could sell their commodities and consumers could buy them at a reasonable price."

In fact, global companies like Cargill and Bunge step into this breach by providing training, agricultural extension services, and financing to small farmers in Asia and Africa.  People in the developing world need their own governments to step up and take responsibility for their own food security.

To put the somewhat abstract discussion of global distribution of calories into perspective, here's a story about the experience of one village in India.

There's no doubt that we've made progress, but there is so much more to do.

Dell's Board Should Come Clean

Today's Wall Street Journal talks about shareholders being on tenterhooks awaiting a proxy in which some self-interested firm will produce a valuation for Dell which will magically manage to support how little Dell's shares are worth based on future results.  Think about the question for a second: this whole process makes no sense.

The easiest thing to do in the meantime?  Have the board release all of the financial and analytical material on which the board decided that a leveraged recap and other alternatives were inferior to the management's proposed buyout.  Then, shareholders would have a benchmark against which to measure the forthcoming guesstimates. It's a really simple proposal, and it would substantiate what are otherwise unconvincing statements by the board.  Have them redact out any intra-board commentary if they want.  As Joe Friday would say during an interview, "Just the facts, ma'am."

I wouldn't hold out hope given all the conflicts of interest in the board room, but it is officially Spring.

Afghan Commander Issues Threat Advisory

What we earlier termed Karzai's Afghan madness endangering our troops has been confirmed by one of our top generals in Afghanistan, according to the New York Times.

"Frustration with Mr. Karzai was clear in the alert, known as a command threat advisory, sent on Wednesday by Gen. Joseph F. Dunford Jr. to his top commanders. “His remarks could be a catalyst for some to lash out against our forces — he may also issue orders that put our forces at risk,” the advisory read....While threat advisories are circulated routinely, one directly from the commanding general is unusual, one Western official said.The threat advisory specifically mentioned Mr. Karzai’s comments about Bagram Prison, calling it an “inflammatory speech,” and warning commanders to be on guard against heightened insider attacks by Afghan forces against Westerners, as well as opportunistic Taliban violence. The order came after a recent rise in violence, including an insider attackthat killed two American service members and a bombing that struck the capital just after Defense Secretary Chuck Hagel arrived for a visit last week."

Going back to Jake Tapper's "The Outpost," the collapse of COP Keating could not have forced without members of the ANA cooperating with the Taliban.  Even members of the local village council were co-opted by the threat of violent reprisals against their family members by Taliban insurgents.  This event came against the background of a cooperative spirit engendered by the Keating commanders at the time.  Little of that spirit exists today, and the risks will be greater as the specifics of our planned withdrawal plan become known by our enemies.

Manic Depressive Analysts Move BBY to Buy

According to the Star Tribune, ten analysts have raised BBY shares "Buy" within the past nine weeks.  Back in November, we took the position that '" 'Renew Blue' Is A Good Start for Best Buy."  Among other things, the group think consensus at that time was (1) Hubert Joly was not the right CEO for the job; (2) the company needed a highly experienced, retail exec, and  (3)  BBY was in a death march due to being a showroom for Amazon and other online customers.  Now, scant weeks later, all of these concerns have evaporated.  Such is the world of financial lemmings.

There was a recent story in the Minneapolis paper about opportunities in large appliances for Best Buy, which is something we pointed out last November.  No chain, including Home Depot and Lowe's does a "category killer" job in major appliances, while Sears has been living off its brand equity.  If Best Buy goes all ultra-high end, that is a risky business.  The whole story is going to boil down to "Right brands. Right Assortments. Right Price Strategy, with good installation and aftermarket service."  Nobody has all the elements right. Local competitors in every market come the closest.

There is still LOTS of  organizational and cultural deadwood to be hacked away by machete, and lots of low hanging fruit to yield near-term improvements.  The cultural change is going to take time and a broom sweeping through the organization.  It may not be the analysts preference for quarter-to-quarter and quarter-over-quarter straight lines, but the potential is definitely there, as it was from the day that Mr. Joly and his team came on board.

Karzai's Madness: Real or Feigned, It's Dangerous

Here's the latest from the WSJ about our untrustworthy ally:

"We have indicated to him in private that public criticism is unhelpful to the partnership, especially when there is no basis in fact for some of the claims he makes," said one senior U.S. official. "We understand that there are issues, but every close relationship has issues and we need to work through them in a constructive manner."This isn't the first time that Mr. Karzai accused the U.S. of conniving with the Taliban. In 2009, he alleged that the U.S. was secretly flying insurgents into northern Afghanistan in helicopters, as part of a plan to destabilize the country.Related Coverage

• Large Explosion Hits Kabul as Hagel Visits

The U.S., other Western allies and Mr. Karzai's administration are engaged in discussions over what foreign military presence, if any, will remain in Afghanistan after 2014.
The U.S. has also been negotiating with the Taliban, but these talks have stalled over several issues, such as a possible swap of Taliban prisoners held in Guantanamo Bay, Cuba, for a U.S. soldier in Taliban captivity, and the Taliban's refusal to talk with Mr. Karzai's representatives.
U.S. officials have envisaged that North Atlantic Treaty Organization allies would make up a large part of the residual force after 2014. Mr. Karzai, however, on Sunday reiterated his opposition to any deal with NATO as a whole, saying countries willing to keep troops here would need to negotiate individual deals with Kabul.
"If you want to stay beyond 2014, all of you separately need to sign agreements with the Afghan people," Mr. Karzai said Sunday. "Limited numbers, in a location we chose and under our conditions and framework, with respect for our laws, our sovereignty, our traditions and culture."
Few if any Western allies would agree to contribute troops to an Afghan mission that is not within the NATO framework, Western diplomats say. "They want us out, that is for sure," a Western official said. "They feel that we are part of the problem."

The only currency that will work with Mr. Karzai is money, not more of our money, but less of his accessible from his numbered bank accounts or other hidden assets.  Relationships are fine, but this one is dysfunctional and manipulative; we are on the wrong end of the manipulation.  The sooner this gets put on the right footing, the safer our troops, personnel and allies will be as we withdraw.

How could we expose our troops to agreements about fixed locations under Afghan jurisdiction? How would any Western allies agree to this foolishness?  Karzai is exposing the Pillsbury Doughboy core of our inept foreign policy and exploiting it to this advantage.