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Private equity parks hope with shareholders, not Dell

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Good news, Michael Dell. Your dogged attempts to talk down the prospects of your company seem to have worked. Just not in the way you intended. Rather than convince your fellow Dell Inc. shareholders to accept your buyout offer of $13.65 (U.S.) a share, you seem to have sowed doubts in the minds of your private equity co-investors at Silver Lake Partners. Silver Lake will reportedly not be heartbroken if the buyout falls apart. Fortunately, Mr. Dell, the only way that Silver Lake will not be ponying up the $1.4-billion in equity it signed up for is if Dell's shareholders reject the offer on July 18.

Dell is supposed to represent the renaissance of the highly leveraged buyout that had been the hallmark of the 2004-2007 M&A boom. But it is also a test case in how companies protect themselves when buyout groups get cold feet at the altar. As the economy and credit markets started to wobble in late 2007, LBO firms threatened to walk away from deals that they had signed up to but which had not yet closed. The terms that selling companies agreed to in order to ensure that deals closed were relatively weak: they figured that buyout firms would not want to tarnish their reputations by reneging on agreed transactions.

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Turns out, buyout firms were ready to walk because they cared more about losing hundreds of millions of dollars buying damaged companies. Today, LBO contracts allow sellers to sue equity and debt sources to ensure they show up to close deals. If litigation fails, the buyers owe a termination fee of about 6 per cent of a deal's value, twice the rate of the old days. In the Dell buyout, the would-be buyers would owe $750-million – 3 per cent of the deal's value but about half of what Silver Lake would contribute if the buyout succeeds.

Silver Lake's only escape is if Dell's shareholders reject the deal. The shareholders want more cash – a successful tactic this year: see T-Mobile, Plains Exploration, or Clearwire. Perhaps Silver Lake's reported apprehension is a way to coax Dell shareholders to feel good about that $13.65 a share. With Dell's shares trading at a shade over $13, fixing it is going to be Silver Lake's problem whether it likes it or not.

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