Dell Reportedly Mulling a VMware Reverse Merger: What Could It Mean?

Austin—Dell may be considering a reverse merger with VMware. Why? Dell has a load of debt and a group of private owners that bought the business off of the public markets in 2013, who may now be ready to get a return on their investment.

News organizations reported during the last week that the Round Rock, TX-based company may be seeking a deal like a reverse merger with VMware (NYSE: VMW), the publicly traded virtualization software and cloud service company in which Dell gained around an 80 percent stake when it bought Hopkinton, MA-based EMC for about $67 billion in 2015. Though Dell is considering other options, including its own initial public stock offering, a reverse merger may let Dell shareholders get a return by selling off some stock in the public market, and could pay down some of Dell’s $50 billion in debt, according to CNBC and Bloomberg reports published Monday.

Analysts appear to see the deal as a positive, for Dell at least, considering its heavy debt position. “Strategically, we think such a deal makes sense for Dell, especially if VMware issues more shares to repay Dell’s debt obligations,” Morningstar analyst Ilya Kundozerov wrote in a research note on Monday.

That high level of debt made other options for a Dell-VMware deal, such as Dell acquiring the remainder of the Palo Alto, CA-based company, risky because Dell would have to spend in excess of $12 billion, Kundozerov wrote in a separate note published on Jan. 26. While a Dell IPO might help the company cut its debt, relying on a good valuation from the public markets is a risky proposition, particularly with challenges its businesses face and its weak balance sheet, according to a note published Monday by William Blair analyst Jason Ader.

Public cloud services such as Amazon Web Services have been growing in popularity, including among businesses. That threatens companies like VMware, which runs virtualized servers for customers in their on-premises data centers, according to Kundozerov from Morningstar. Kundozerov says VMware should be able to maintain customers for the foreseeable future, including larger organizations that may be skeptical of public cloud vendors. However, the analyst believes that VMware stock is overvalued, even after it dropped by 16.5 percent to $125.05 per share after the reports of the potential reverse merger were released.

That suggests that the deal may not appear as appealing for VMware shareholders, though they wouldn’t be able to block it because Dell owns more than 90 percent of the VMware voting rights, according to Ader of William Blair. There are a couple reasons Dell could be apprehensive about a deal, Ader says. Employee attrition is a possibility, if people don’t want to work for a different company. And VMware’s vendors might perceive a loss of neutrality if it were to combine with Dell, Ader says.

Notably, Kundozerov wrote that it’s conceivable a combined business may eventually seek to follow Hewlett-Packard’s lead and split itself into two companies again, carving out its consumer division. HP announced plans in late 2014 to split itself into two companies, the consumer-focused HP (NYSE: HPQ) and business-focused Hewlett Packard Enterprise (NYSE: HPE).

David Holley is Xconomy's national correspondent based in Austin, TX. You can reach him at [email protected] Follow @xconholley

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