Investors brace for Dell's high profile jumbo LBO financing

Fri Aug 30, 2013 1:59pm EDT

* Sept shareholder seen as last hurdle before debt launch

* Dell faces tricky marketing after takeover fight

* Existing bonds structurally subordinated by new debt

By Rachelle Kakouris

NEW YORK, Aug 30 (IFR) - US computer giant Dell Inc is tipped to launch its jumbo leveraged buyout financing next month, as it looks to get in ahead of raft of other high yield issuers and before US Treasury yields rise further.

The sheer size of the estimated USD13.75bln debt financing means that it will be one of the most high profile deals to hit the market. Although leveraged loans are expected to take up a large portion of that, the bond is also likely to be sizeable at around USD3.25bln and split between first and second lien notes.

"Dell is the Elephant in the room that everyone is talking about that could potentially move quickly post Labor Day," said one banker close to the situation.

One portfolio manager, who declined to be named, said the market had the capacity to absorb the bond.

"The real interest is the high profile of the company, the actual fight, the fact that it is a fallen angel, and from a risk standpoint, the fact that it has to transform itself," the manager said.

Dell agreed to go private in February in a USD25bn deal led by founder Michael Dell and private equity firm Silver Lake and Microsoft Corporation. A subsequent battle for the business between Dell and activist investor Carl Icahn means that the financing will now take place in far less favorable conditions.

The market has become choppier on fears that the Federal Reserve will begin its bond buying retreat as soon as September, while geopolitical risk has soared over the past week.

A conflict with Syria is now at the forefront of concerns.

"Were bracing for some pretty volatile markets," warns Gershon Distenfeld, director of high-yield debt at Alliance Bernstein.

"Besides the Syria situation and some potential problems in emerging markets, there is a lot of uncertainty surrounding the US debt ceiling and Fed tapering," Distenfeld said.

TRICKY TIMING

Sources say that the company was originally looking to come in the early Springtime.

The yield to worst on the closely watched Barclays US High Yield Index has risen to 6.38% from around 5.2% at the beginning of May, while underlying rates have spiraled with 10-year Treasury yields rising to 2.75% from 1.74%.

"It's probably going to cost them more than 200bp from where they could have funded had it not been delayed," said the portfolio manager.

Given the shutdown in primary high-yield since August 16, Dell could well set a new benchmark for pricing and provide a barometer for investor appetite for riskier debt, but just how quickly the deal could be launched remains unclear.

The underwriters - Bank of America Merrill Lynch, Barclays, Credit Suisse and RBC - would probably like to move before the next Fed meeting on September 16-17, but a shareholder meeting to approve the LBO, scheduled for September 12, could be a constraint.

The underwriters were either unavailable or declined to comment on the timing, or whether an extensive roadshow would be launched.

DETERIORATING SECTOR

Aside from the general market conditions, Dell also has a tough story to tell.

During negotiations with shareholders, Dell argued for a lower price because the computer market is shrinking, but bondholders may use that as leverage to demand higher coupons.

Then there are the expected further downgrades to the company's credit to contend with, and the likely structural subordination by the new debt.

Dell's long-dated outstanding bonds took a massive hit when news of the takeover broke in January. Dell's 5.4% September 2040s, for example, are now trading at 350bp over Treasuries versus 200bp in early January.

In keeping with high grade convention, Dell's existing bonds do not have change of control covenants, a clause that would have offered investors significant protection.

"Suddenly you are facing major problems as an existing bondholder," said Steven Oh, head of global credit and fixed income at Pinebridge Investments.

If total leverage rises sharply, the company's investment-grade ratings are expected to slide into junk territory, which may create forced selling by certain investors.

Moody's downgraded Dell to Baa1 from A2 in February and warned of a multi-notch downgrade if the deal goes ahead, while S&P, which lowered Dell's corporate credit and senior unsecured debt ratings to BBB from A- in May, expects its corporate credit rating outcome likely to be no higher than BB.

"The existing bonds are going to be subordinated to all of the new debt so not only has the business been levered and the debt downgraded, you are now being pushed down the capital structure," said Oh.