The last few days have been highly eventful for VMware Inc (NYSE:VMW) as investors try to figure out what will happen with them and Dell. On Friday, reports that Dell was considering an IPO and buying up VMware saw VMware’s stock, which had already performed well over the past year, shoot up by over 10 percent. But on Monday, CNBC reported that “VMware could buy Dell in massive reverse-merger, sources say. VMware lost all of Friday’s gains and some more, closing on Monday at $125.05.
No one knows what is going to happen to a certainty. Reports indicate that both a Dell IPO and a reverse-merger are merely possibilities which Dell executives are discussing instead of concrete decisions. But what is clear is that now is a good time for investors to examine their holdings in VMware.
While some investors may tell you that VMware’s stock is still undervalued, the recent reports of a reverse merger are concerning for VMware and more likely than a Dell IPO. There are other concerns as well, and investors who before may have considered VMware should stay away until there is more information.
The VMware-Dell relationship
To recap things from the beginning, Dell went private in 2013 as it transitioned from selling personal computers to supplying hardware and software to corporate data centers. In 2015, Dell acquired EMC Corp (NYSE:EMC) for $67 billion in 2015 and obtained 80 percent of VMware stock at the same time. The other 20 percent stayed on the market, and VMware stock had nearly doubled over the past 12 months before Monday’s collapse.
Dell owns VMware, but would essentially sell itself to VMware as part of the reverse merger. While investors do not know what Dell is currently worth, we can presume that it is worth more than $67 billion, which USA Today notes would make it the biggest tech deal in history.
But why is Dell considering a reverse merger or going public, especially since CEO Michael Dell has spent years talking about how he was happy not having to worry about investors every quarter? Because Michael Dell may not like investors, he does need our money to deal with Dell’s serious debt load.
Bloomberg reports that Dell has over $52 billion in debt and spent $2 billion over the past 12 months to handle interest payments. Much of this debt is frontloaded and set to come due in 2021 and earlier. Furthermore, the recent U.S. tax bill limits how much interest expense companies can deduct from their taxes, which would further encourage Dell to get out of debt quickly.
Given Dell’s problems, a reverse-merger is more likely than an IPO. Dell would have to persuade investors to buy shares for a formal listing, which would be tricky as investors would not be interested in seeing their money just pay off Dell’s debt. But in a reverse merger, Dell would be compensated for with VMware stock which has performed very well, and perhaps even give Michael Dell and executives an opportunity to cash out.
VMware’s problems
A reverse merger could be good for Dell, but it would be a different story for VMware. In addition to giving up shares, Dell could also shunt some of its debt onto VMware’s books, relieving its debt load at VMware’s expense.
Dell might counter by arguing that VMware and Dell merged together would be highly synergistic. VMware specializes in virtualization software, often used in providing password security in sensitive situations, which lets companies cut costs and store more data by combining multiple operating systems on a single PC. Meanwhile, Dell sells corporate application to companies, which can now use more applications with VMware’s virtualization software.
But this touches onto another problem with VMware’s prospects which have nothing to do with Dell. Virtualization was revolutionary technology five to ten years ago, but companies are steadily moving towards storing data on the cloud with servers like Amazon (NASDAQ:AMZN) Web Services. VMware has continued to grow and be profitable as the corporate world’s transition to the cloud will be slow, but it has a lot of work needed to stay a leader in data collection services.
Wait and See
Dell will likely reach a decision on how it will relieve its debt load in early February, and it is possible that the fervent speculation which bought VMware up and then crashed it down is empty noise. But a reverse merger would be a major blow for a company which already has to figure out how it will compete with cloud technology. VMware performed well throughout 2017 in a bull market, but investors are better off waiting for more concrete news about Dell and figuring out if the market will continue to stay hot. VMware is not a bad buy, but a little more caution and time is needed for this company.