Shareholders aren't exactly applauding Dell Inc.'s plan to take itself private. The biggest source of opposition comes from Southeastern Asset Management, Dell's largest outside investor and one that has been beset with poor performance.
Southeastern is run by deep-value investors Mason Hawkins and Staley Cates, who love to bet on struggling companies in the hope that the market is taking a far too pessimistic view, leaving big upside opportunities over the longer term.
Dell seemed to fit in nicely with this approach. The computer maker has suffered from declining market share and rising concerns that the PC era is fading. Its prospects, though, were deemed salvageable, especially if its move into higher-end servers were to pay off.
Now, with founder and chief executive Michael Dell and his backers trying to buy out existing shareholders at $13.65 (U.S.) a share – a premium over the stock's recent lows but well below previous highs – Dell could be whisked away from Southeastern's portfolio before the asset manager can make any gains from it. (Forbes estimates it is facing a loss of at least $1-billion on the investment.)
The decline of Dell's share price in recent years has hurt Southeastern's flagship Longleaf Partners Fund. Over the past 10-year, five-year and three-year periods, the fund has underperformed the benchmark S&P 500. Southeastern's international fund has also been struggling because of other soured investments. It has lagged behind the benchmark EAFE (Europe, Australasia and Far East) index over the past 10-year, five-year and three-year periods.
This underperformance undermines Southeastern's once-solid reputation for longer-term performance. Both funds have beaten their respective benchmarks since their inception and Mr. Hawkins and Mr. Cates – while not household names – are highly respected investors.
But the trouble with deep-value investing, as with any strategy, is that there are times when it simply doesn't yield attractive results. Those who dive deep for bargains buy beaten-up stocks in the belief that markets are irrational enough to provide bargains but rational enough to eventually recognize pricing errors – taking stocks out of the bargain bin and placing them back on the premium shelf.
Southeastern maintains that Dell would naturally return to the premium shelf or at least see its value rise to about $24 a share. By its account, the offer to take Dell private undervalues the company by 75 per cent because it looks simply at its cash, recent acquisitions and its finance arm. The offer places almost no value on Dell's server, software and PC businesses, which prompted Southeastern to call it "woefully inadequate" in a regulatory filing last week.
The current offer to shareholders "clearly represents an opportunistically timed bid to take the Company private at a valuation far below Dell's intrinsic value, and deprives public shareholders of the ability to participate in the Company's substantial future value creation," the filing said.
Southeastern doesn't intend to sit quietly by and watch the deal go through. It said it intends to use all options at its disposal – including a proxy fight and litigation.
Should this turn into a brawl, it is going to be hard to know which party to root for. If Southeastern gets its way, Michael Dell and his backers could easily scrap the deal as too expensive. If that should happen, Dell's share price would likely fall back to where it was before the deal-rumour began circulating. Expect a setback of 25 per cent.
And if Southeastern's concerns are met with silence, the computer maker could indeed be swept up at a discount price that leaves bargain-hunters – and patient long-term shareholders – fuming.
For Southeastern, there's a lot at stake. After suffering setbacks with a string of recent investments – including Chesapeake, Olympus, Allied Irish Bank and Level 3 Communications – the investment firm is looking accident-prone.
And perhaps most damaging of all, deep-value investing is starting to look like a dangerous investment strategy.
David Berman