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Continued debt reduction at Dell underscores positive credit view

| January 22, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

As the widest trading credit in the technology curve, our positive view on Dell Technologies (DELL) secured bonds is underscored by management’s continued focus on debt reduction. A potential spin off of VMware (VMW) later this calendar year could provide DELL with proceeds close to $15 billion for further debt reduction. This would increase the likelihood of a ratings upgrade, which could result in DELL’s long-end bonds outperforming those of closely-rated peer Broadcom.

DELL is on track to repay $5.5 billion in total debt for fiscal year 2021 (ending 1/31/2021), of which $3.1 billion was repaid in the first three quarters. Relative to closely rated Broadcom Inc. (AVGO – Baa3/BBB-/BBB-), DELL trades only 20 bp (g-spread) behind AVGO in the 10-year part of the curve. However, the DELL 8.35% 7/15/46 bonds trade 133 bp (g-spread) behind AVGO 3.75% 2/15/51 bonds. The large spread differential takes into account the high dollar price associated with DELL’s bonds. Assuming 1.5 bp of additional spread per each dollar above par on DELL bonds coupled with a 20 bp differential behind AVGO (similar to the 10-year), that would put fair value on the DELL 2046 bonds at roughly 270 bp (g-spread). That translates to 40 bp of upside from current trading levels.

Exhibit 1. Technology BBB 20-to-30-year curve

Source: Bloomberg TRACE; Amherst Pierpont Securities

Core Debt Leverage Now Below 3.0x

DELL has been actively repaying debt since the close of the EMC acquisition in 2016, with roughly $17.4 billion of debt repaid since then. At the close of the acquisition, DELL’s total debt balance stood at just below $49 billion. DELL ended the most recent quarter with $31.4 billion of core debt, translating to a core leverage ratio of 2.9x, which was also down three ticks on a sequential basis. DELL is targeting a core leverage range of 2.0x-3.0x and is currently at the high end of that range. Given that DELL is expected to repay another $2.4 billion of debt in fiscal 4Q21, the company is likely to end fiscal 2021 with core leverage in the 2.7x area (assuming no EBITDA growth). While the agencies look at other metrics aside from leverage when assessing ratings, S&P closely ties leverage to its ratings. That said, with leverage now below 3.0x, DELL is within S&P’s parameters for an upgrade to investment grade at the parent level. Furthermore, management noted that even being within its leverage target range, debt reduction will remain a top priority as they continue to work to achieve investment grade ratings.

Exhibit 2. DELL Core Debt and Leverage (EMC Close – 3Q21)

Source: Dell 3Q21 Presentation; Amherst Pierpont Securities

Spin of VMW Would be a Catalyst for Further Meaningful Debt Reduction

DELL filed an amended 13D in July 2020 regarding its exploration of potential alternatives for its ownership interest in VMW. DELL management has noted that a tax-free spin could not only drive significant shareholder value but also maintain its strong commercial partnership with the company. A spin will help simplify the existing capital structures of each company while enabling strategic flexibility for DELL. Due to tax implications, the earliest a spin could close would be September 2021. A spin announcement is expected to be made should DELL and VMW come to an agreement that provides for mutually beneficial commercial arrangements and capitalization that provides for investment grade ratings for both companies.

Both DELL and VMW have publicly discussed the potential benefits of such a transaction. In a spin off, we expect VMW to raise debt in order to fund a dividend payment to DELL as part of the separation agreement. It has been rumored that DELL could receive a cash payment in the $10- to-$15 billion range, which could be used to drastically reduce its current debt balance. We would also expect low to mid BBB ratings to be target by VMW in a spin. That said we think leverage at VMW would have to be in the 3x-4x range with the potential to decline over 18 months post transaction. Consensus estimates put VMW’s EBITDA for fiscal 2021 at $4.6 billion. Layering on an additional $10 billion-$15 billion of debt to its balance sheet would put pro forma leverage in the 3.3x-4.4x range. Given the low capital intensity of VMW’s business, VMW could conservatively reduce debt in the $3 billion range post transaction, bringing leverage down to the 2.7x-3.8x range. For Dell, reducing debt by an additional $10 billion would put core leverage below 2.0x.

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