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VMware spinoff would shrink debt, but Dell needs to keep cloud focus – analysts


Dell Technologies Inc. is looking for ways to maintain the ability to offer a one-stop shop for enterprise customers interested in hybrid cloud systems, even as it explores a potential spinoff of its 81% stake in VMware Inc. as a debt-reduction strategy.

Dell on July 15 confirmed a June report by The Wall Street Journal that said it was exploring options for the stake, worth approximately $50 billion. Dell described the process as an early-stage exploration of its options aimed at improving its credit rating and simplifying the capital structure of both Dell and VMWare.

The spinoff, should it occur, would happen after September 2021, when a potential tax penalty for spinoffs associated with Dell’s 2016 acquisition of EMC expires, Dell said. Industry analysts said the transaction would yield benefits for Dell’s financial structure, but strategically, it needs to maintain a strong footing in the future of cloud-based offerings like those it provided through its collaboration with VMWare.

“VMware obviously has seen a massive upside from the motion in sales it gets from Dell,” said William Fellows, a cloud-transformation analyst, research vice president and co-founder of 451 Research. “But VMware is one of those companies like Cisco or Oracle in that where they go, the industry follows. It’s hard to see a direction of travel for Dell without VMware.” 451 Research is an offering of S&P Global Market Intelligence.

Dell indicated in SEC filings that it is weighing a range of potential options for VMWare, but the one it described in detail would allow VMware to separate from Dell after taking on an unknown amount of debt to pay its shareholders, namely Dell.

Dell, in turn, would use the cash to reduce its substantial debt pile, among other general corporate purposes. Dell reported about $57 billion in total principal debt as of May 1, up from $53 billion it reported Jan. 31. The company attributed the increase to new debt issuances, including a $2.25 billion bond issuance in April, taken to help support company operations during the economic uncertainty of the pandemic.

Dell is facing a $5.5 billion debt repayment this year, though CFO Thomas Sweet said in a June 16 online discussion that the company has the resources to cover it. Much of Dell’s debt relates to its acquisitions of EMC and VMware in 2016.

“Dell’s equity owners have felt that their shares are not fully reflective of their ownership in VMware, so spinning off VMware is likely their best way of capturing some of that value for Dell, which they believe would better reflect its true value,” said Andrew Chang, credit analyst at S&P Global Ratings. “They said they’re still considering their options, including maintaining the status quo, but a spinoff is probably the most likely option because it’s the best way to capture that value for core Dell.”

Dell specified in July 15 SEC filings that any separation would be done in a way that preserved VMware’s investment-quality credit rating and helped Dell move forward with efforts to get its credit rating back to investment grade. However, many details about the potential separation, including the potential size of the proposed dividend, remained undisclosed.

“From our rating-agency perspective, we have no idea how much VMware might borrow if they were to provide a dividend to Dell and, more importantly, this is not going to happen until September of 2021,” Chang said. “So there are a lot of question marks here.”

Spinoff or not, however, Dell said it does not intend to fully disentangle itself from VMware. It wants to preserve efforts to present its customers with a full-service offering able to install or build the hardware, networks and software platforms that go into the modern hybrid cloud installations, which Dell sees as a major target for enterprise customers. That includes continuing to support services and products developed with VMWare.

If a spinoff occurs, the companies would work to strike agreements to “formalize mutually beneficial commercial arrangements similar to those currently in place,” according to a July 15 statement. This would include “go-to-market, services, research and development, and intellectual property agreements” designed to provide continued support to current strategic priorities and customer services.

But “special relationships” among major vendors tend not to last long in the technology business, Fellows said. Also, selling VMware to an integrator such as Hewlett Packard Enterprise Co., or to Alphabet Inc.’s Google LLC or another cloud-platform provider, would reduce its ability to provide a central point of integration and control in complex hybrid-cloud architectures.

“VMware is raking in the dough based on its ability to reach across the cloud in all its permutations, public, private, managed,” Fellows said. “Dell is obviously is in a different situation, with a bag of money shackled to it without the ability to take advantage of it … I still think they are better together.”

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