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Dell is one step closer to investment grade with VMware spin

| April 16, 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.

Dell Technologies Inc. (DELL) announced on April 14, 2021, that it would be spinning off its 81% equity ownership of VMware Inc. (VMW). With the spin announcement, DELL may look to execute a tender offer to help improve its interest cost profile while reducing debt given that its capital structure is littered with coupons in the 6%-8% range. DELL currently has two debt maturity walls in 2023 and 2026 which will likely be targeted, but the 8.35% 7/15/46 bonds also have a high likelihood of being tendered given that they are the highest coupon in the capital structure.

According to the terms of the spin, VMW will distribute a special cash dividend in the range of $11.5 billion-$12 billion to all shareholders, which equates to an expected $9.3 billion-$9.7 billion in proceeds to DELL.  According to management, the spin helps to unlock value in VMW while providing DELL with proceeds to execute on its core debt reduction plans and position the company for investment grade ratings. DELL shareholders will receive approximately 0.44 shares of VMW for each share of DELL based on shares outstanding as of the aforementioned date.  The deal is expected to close in the fourth quarter of 2021 and is subject to the receipt of a favorable IRS private letter ruling that the transaction will qualify as a tax-free spin to DELL shareholders. Each share of VMW class B common stock will automatically convert into one share of VMW Class A common stock. A shareholder vote is not required for the spin.

The announcement prompted a significant move across DELL’s corporate curve with bonds roughly 20 bp tighter post announcement. When we last wrote on the credit (2/12/21) we had discussed DELL senior secured bonds being the widest trading credit in the technology curve. While spreads have tightened since the last publication with the broader market and yield grab, we had felt that there was further upside for DELL to collapse closer to Broadcom Inc. (AVGO – Baa3/BBB-/BBB-) particularly in the back end of the curve, given that DELL’s 10/30s curve was much steeper than AVGO’s.

Core Debt and Leverage to be Dramatically Lower

Post spin, DELL’s debt structure is expected to be much lower and far less complex. DELL plans to repay its existing $4 billion margin loan prior to the close of the transaction while VMW’s $4.8 billion of debt will no longer reside on DELL’s balance sheet. Additionally, the VMW dividend proceeds will be used to pay down core debt.  Given DELL’s previous announcement to repay $5 billion of debt this year, the dividend proceeds will bring core debt repayment to over $14 billion. That said, DELL should end the fiscal year with total core debt of approximately $15 billion given that the company ended its last fiscal year with core debt of $29.2 billion as referenced in Exhibit 1. Management also noted that it will be targeting core leverage of 1.5x post spin, which is below its original target range of 2.0x-3.0x. DELL ended the most recent quarter with core leverage of 2.5x.

Exhibit 1. DELL Debt Summary

(1) Amounts are based on underlying data and are rounded
(2) Principal Face Value
(3) Core Secured Debt represents secured term loans, IG notes, and revolver.  It excludes DFS debt.
(4) Core debt represents total debt less: unrestricted subsidiary debt; DFS debt and other debt
(5) VMW and its subsidiaries are considered unrestricted subsidiaries for purposes of existing debt at DELL.
Source: DELL Company Presentation; APS

All Ratings Now on Review for an Upgrade

Subsequent to the release, all three rating agencies put DELL’s ratings on review for an upgrade.  Moody’s noted that with the use of proceeds from the spin and the additional $5 billion of debt reduction that was slated for this year, DELL will have reduced its core debt and loan balances by approximately $34 billion since the close of the EMC acquisition in September 2016. These actions support management’s commitment to attain Investment Grade ratings. As such, Moody’s will likely raise the company’s senior unsecured rating by two notches to Baa3. S&P noted that the corresponding debt reduction associated with spin is expected to bring leverage below the mid-2.0x level, which is the agency’s upgrade trigger. Management is expected to adopt a financial policy post spin that supports maintenance of leverage below the mid-2.0x threshold. Fitch noted that it plans on upgrading DELL’s unsecured ratings to BBB post spin close with its senior secured rating one notch higher.  We note that once two of the three rating agencies rate DELL’s senior unsecured debt Investment Grade, DELL’s restricted subsidiaries will be able to release guarantees and collateral pledged to creditors.

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