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EMC and VMware Shareholders Demand Changes to Dell Buyout Deal

Or else ...


EMC and VMware shareholders, who have watched their stock prices plummet over the six weeks since computing giant Dell announced an ambitious but complex plan to buy out storage company EMC, are demanding a series of actions they hope will stop the free fall.

Some institutional shareholders have asked EMC and Dell for three specific actions they say will improve their confidence in the proposed $67 billion buyout, the biggest tech deal of all time, and increase the chances they will vote in favor of it, people familiar with the demands told Re/code.

“They have to improve the deal, and if they don’t, we’re going to vote against it — and a lot of other people are going to vote against it,” one shareholder, whose firm owns several million shares of EMC, told Re/code.

The three demands by some institutional shareholders are designed to address the 30 percent drop in VMware shares and 9 percent drop in EMC shares since the Oct. 12 buyout announcement.

  • VMware should buy back as much as $3 billion worth of VMware shares.
  • EMC and VMware need to unwind Virtustream, a cloud computing company the pair announced as a new joint venture and whose creation came only eight days after the Dell buyout deal. The Virtustream announcement is being blamed for further dragging down VMware shares and damaging the implied value of a proposed class of tracking stock that would be used to help Dell pay for the deal.
  • The shareholders have also asked for an adjustment to the rights and protections attached to a proposed block of tracking shares linked to VMware. The shareholders say the suggested changes are intended to give owners of the tracking shares rights and protections more closely aligned with owners of VMware common shares. As one shareholder put it, “We want them to put some real governance behind the tracker” in order to prevent Dell from “totally running roughshod over VMware.” For example, if VMware were to someday pay a dividend to its common shareholders — it doesn’t pay one currently — owners of the VMware tracking stock would collect one as well.

Overall, the shareholders don’t see the changes they’re advocating as fundamentally changing the structure of the deal. “The chart of VMware stock over the last six weeks should tell you a lot,” one shareholder said. “VMware is a great company, but it’s trading at an absurdly low price right now, and Dell should understand why that is,” one shareholder said.

Of the three demands, the one least likely to be addressed is any changes to the tracking stock rights, a source familiar with Dell and Silver Lake’s thinking told Re/code. The source said the buyers have ruled out any revision to tracking stock rights because any changes would involve a revision to the definitive merger agreement, which is considered set in stone. Additionally, without a competing buyout offer — a 60-day period mid-December during which EMC was allowed to shop around for a better deal — Dell and Silver Lake have little incentive to revise the terms.

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Meanwhile, the unwinding of the Virtustream joint venture may already be in motion, according to Toni Sacconaghi, the influential analyst from Bernstein Research who published his suspicions in a note on Monday. The Virtustream plan called for the creation of a 50-50 joint venture combining the cloud computing and services assets of EMC and VMware. VMware would get all of Virtustream’s revenue, assume half its losses — and eventual profits down the road — and contribute as much as $250 million in new capital spending to get it up and running.

However, the timing of its creation coming so close on the heels of the Dell acquisition irritated some shareholders, who worried that Virtustream appeared to be a “dumping ground” for money-losing assets. Worse, the announcement coincided with VMware’s quarterly earnings report, which forecast weak revenue expectations for 2016. VMware shares fell 19 percent on Oct. 21, the day after Virtustream was announced.

The timing exacerbated the “fear and uncertainty” surrounding Dell’s intentions for VMware once Dell takes control of EMC, Sacconaghi wrote. Still, shutting down Virtustream might not solve the problems that shareholders perceive. While VMware would no longer need to fork over hundreds of millions to finance the operations, it would also lose an estimated $300 million in Virtustream revenue next year. In the absence of a joint venture, VMware would need to lower its guidance for 2016. As Sacconaghi put it: “VMware needs to pick its poison … or find a crafty way to capture the best of both worlds.”

Buying back VMware shares would appear to be the least controversial and least complicated way to shore up its sagging share price. But even that is complicated by the facts. VMware has a combined $7.2 billion in cash and short-term investments on its balance sheet. Of that, $5.7 billion is held outside the U.S. and so would be subject to corporate taxes if it were to be repatriated. Shareholders pushing for the buyback have suggested taking on debt to pay for it.

Spokespeople for Dell, EMC and VMware declined to comment. A spokesman for Silver Lake, the private equity firm that co-owns Dell and is involved in the buyout process, also declined to comment.

Update: Shortly after this story was published Reuters reported that EMC and VMware plan to change its plan for Virtustream, citing anonymous sources familiar with the matter. Under the new plan, EMC will own a majority of Virtustream and VMware a minority stake. An announcement of the plan could come as early as December, the sources said.

VMware shares closed higher by nearly 4 percent at $60.35 on the New York Stock Exchange. EMC shares rose 47 cents to close at $25.47.

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