Dell buyout could mean more debt, junk rating

Wed Jan 16, 2013 12:47pm EST

NEW YORK, Jan 16 (IFR) - As talks have advanced to take Dell Inc private, analysts say the computer giant will have to take on billions of dollars more in debt - and may even face a ratings downgrade to junk.

The mooted leveraged buyout of Texas-based Dell would be one of the largest LBOs ever, considering the company's current market capitalization of $21 billion.

Some estimate a purchase price of as high as $25 billion, meaning that sponsors would need to raise about $15 billion in capital to complete the deal.

That figure would be based on rolling in the equity of founder Michael Dell as well as a limit on leverage of three times EBITDA, said Morningstar analyst Michael Hodel.

If half of that capital comes out of the $14.2 billion of the company's cash and investments on hand, it would be left with gross debt of about $14 billion after the buyout, Hodel said in a report.

"That balance sheet wouldn't be awful, but it would require that Dell stabilize its operating performance in relatively short order and begin paying down debt," he said.

The buyout would also significantly change the character of the company's existing roughly $9 billion of investment-grade debt.

While Dell is currently rated A- by Standard & Poor's and A2 by Moody's, the outstanding bonds would be downgraded to reflect the increased leverage risk after a buyout.

One leveraged finance syndicate banker who asked not to be named said Dell could be demoted to double-B - the highest-rung of the high-yield, or junk, category.

In fact, Dell's CDS or credit default swaps - essentially the price investors pay to protect against a company defaulting on its debt - are already trading at a level that implies a double-B rating for the company.

But any downgrade would still have relatively little impact on Dell's ability to tap the capital markets for funding in the months ahead, the bond syndicate banker said.

"A company like Dell could tap a lot of different sources," he said. "What these headlines have done is make people take notice that a deal of this size could be financed in this market."

Indeed, Dell would likely be able to tap sources including the pro-rata market, which is comprised of term loans A and revolver facilities, the term loan B market and asset-based market, as well as both secured and unsecured notes in the bond market.

"The leverage is pretty low, so you could maximize all of those different buckets," the banker said. "Given that some of these deals lately have had very big order books, when you put it all together, you could raise $12 billion to $15 billion of debt for a real blue-chip name."

ALREADY MOVING

News of the buyout plan has put a floor under Dell shares, which were trading at $12.61 on Wednesday, up 15.9% since the beginning of the week.

But without language in the company's existing bonds about change of control, some are trading below par value since talk of the buyout emerged.

Spreads on Dell's 5.875% notes due 2019 were trading 97 basis points (bp) wider on Wednesday at Treasuries plus 352 basis points, and the 4.625% notes due 2021 were 64bp wider at 355bp over Treasuries.

The Dell 5.4% notes due 2040, meanwhile, were trading at 87.5 cents on the dollar, after starting the week at 105.50.

In addition to having an impact on Dell's current debt, the buyout talk has revived talk in the market about a genuine revival of LBOs, which have been few and far between since the onset of the global financial crisis in 2007.

Dell's would be the largest buyout since that year, when another Texas company, energy utility TXU, carried out a $45 billion leveraged buyout, that was the biggest ever.

The average option-adjusted spread on the Barclays high-yield bond index - currently around 471bp, its lowest level since May 2011 - is one of the best indicators for LBO activity, said Marty Fridson, CEO of New York-based financial firm Fridson Vision.

"The key to the story is that the cheaper it is to finance LBOs, the more LBO financing gets done," Fridson said in a recent report.

"Present conditions point to a significant increase in LBO volume over the 2011-2012 level, but not to anything like the record level of 2006-2007," he said.

In both 2011 and 2012, the weekly average of the spread was right around 600bp - and LBO volume in the United States was $100 billion in each year.

In the peak LBO years of 2006 and 2007, the spread averaged 325bp and 361bp, respectively, and LBO volume was roughly US$600 billion per year.

At the current level, Fridson estimates, there would be around $132 billion in LBO volume this year.

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