What’s Next for VMWare Stock After the Dell-EMC Deal? (VMW)

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The short version: Dell is buying data-storage outfit EMC Corporation (EMC) for $67 billion in cash and stock.

Not only is it the biggest-ever acquisition within the tech sector, it’s also one of the most complicated. Either way, owners of VMware (VMW) have crunched their numbers, and judging from today’s 10% dip in the value of VMWare stock, they’re not happy with the way things are adding up.

What Now for VMWare Stock, Here in the Middle?Yes, the long-rumored acquisition of EMC by privately held Dell — with some help from private equity firm Silver Lake Partners — is finally happening (probably).

If it does pan out as scripted thus far, however, the deal is going to be the least-desirable option for current VMW stock owners. EMC investors aren’t exactly thrilled, either.

The Deal

It’s a smart fit. Dell has hit the same headwind most PC makers have hit lately, and though the server market is still alive, it has been in the shadow of cloud-based services. By teaming up, Dell and EMC become a one-stop solution, and can cross-sell to one another’s existing client base.

Specifically, current EMC shareholders will be receiving $24.05 in cash, and the remainder of the deal’s value of $33.15 per share of EMC will be made up of a tracking stock designed to mirror the value of VMWare stock. All told, EMC investors will receive about 0.111 shares of the VMW tracking stock per share of EMC.

The concept makes sense, more or less. EMC Corporation is the biggest single stakeholder of VMWare, owning 81% of the outstanding shares of VMW. Soon, Dell will own that 81% stake in VMWare, which makes software that adds versatility to personal computers.

But, rather than simply sell some or all of that stake in VMWare, or even just somehow distribute it directly to EMC investors, Dell and Silver Lake have opted to create a VMW tracking stock specifically for EMC shareholders.

It’s an unusual-though-not-unheard-of idea, and in this case, it’s an idea the market doesn’t like, even if it doesn’t quite know why it doesn’t like it.

The Math

The deal itself isn’t upsetting. The upsetting aspect is the math.

The offer price of $33.15 less the $24.05 in cash implies one share of the soon-to-debut VMWare stock is worth $9.10 apiece (note that there’s no particular correlation to the price of actual VMWare stock).

At those levels, the offer implies EMC’s VMWare stake is worth $20.8 million, while EMC as a stand-alone company is worth $46.2 billion. Problem: An 81% stake in VMWare should be worth $24.2 billion.

Granted, as the proverbial D-Day approaches, the value of the tracking stock could climb to reach parity with its actual counterpart. That’s a $3.5 billion disparity, though. Even if that gap is fully closed, the overall offer still lacks the premium that has become almost requisite for tech-sector deals.

Bottom Line for VMWare Stock

The irony of the situation is, of all the parties that have reason to feel slighted, current shareholders VMWare have the least to be upset about — their shares (the “real” ones) won’t see any change on a per-share performance basis. But VMWare stock is getting hit the hardest.

On the other hand, though it’s more perception than reality, the last thing VMWare stockholders want to see from here is a flood of disenchanted EMC investors dumping their tracking stocks of the same company, nearly flooding the market with supply of the stock.

If anybody has something to gripe about, it’s arguably current EMC investors, who will soon be receiving a tracking stock that may or may not reflect the true value of Dell’s stake in VMWare; tracking stocks don’t have the best track record of doing what they’re supposed to do.

So the question becomes … why do it? FBR Capital Markets’ Daniel Ives may have the most palatable explanation:

“While many EMC shareholders will likely argue that breakup value is in the $35-$38/share range (and we strongly agree), it appears that Tucci/board would rather go down the aisle with Dell than pursue a breakup, a smart strategy, in our opinion — as the $33 price tag is very fair. This is a landmark deal that will have wide-reaching ramifications across the tech landscape for years to come. After years of a status quo situation, with the antiquated Federated strategy (80% ownership of VMware) and sagging growth prospects, it came down to Elliott riding in with a white horse to finally shake this situation up and have Tucci and the board pursue a value-enhancing deal as the clock was about to strike 12.”

In other words, in this case the sum of the parts may not be greater than the whole. If that really is the case, then current owners of VMW stock may have actually just gotten a break.

Still, it would have been nice if Tucci at least seemed to try to get maximum value for both VMWare and EMC. It’ll be interesting to see if any other interested parties express interest over the course of the coming 60 days during EMC’s “Go Shop” period.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/10/now-vmware-stock-middle/.

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