title small bio t4 t9
t1 t5 t10
t3 t6 t11
t2 t8  




Recapitalization and value

The Discussion Issue

If changing the mix of debt and equity can change your cost of capital and affect value, it stands to reason that companies that have sub-optimal mixes of funding can increase their values by moving to their optimal debt ratios. For a firm that has too little debt, relative to its optimal, this usually takes the form of a debt for equity recapitalization, where the firm borrows money (thus raising debt) and pays a special dividends or buys back stock (thus reducing equity). When these recapitalizations do happen, it is easy to get distracted by side stories. Thus, the notion that buybacks increase value because they reduce the share count is not delusional but dangerous. If this were true, all companies should keep buying back shares before they becomed leveraged disasters.


To set the general stage for where we are in the leveraged recapitalization cycle in this market, start with this Wall Street Journal story:


You can follow up with this story from Forbes on leveraged special dividends:


One of the companies highlighted in the Wall Street Journal story is Dell, where Michael Dell and Carl Icahn fought over the future of the company, though both agreed that the company should borrow more money. Here is Michael Dell's rationale for why:


And here is Carl Icahn's defense of his plans for Dell:


The fight ended with Dell winning and Icahn giving in:


Finally, here is a blog post I had on Dell at the start of the fight:


If you want to take a look at Dell's most recent financial statements, here is the link to their last 10K.


Unfortunately, with a year-end in February 2013, it is dated. You can construct a trailing 12-month value, if you are interested.

Key Questions

  1. While Michael Dell and Carl Icahn had different views on whether Dell should go private, they both seemed to agree that Dell should have a lot more debt? Given that Dell is a technology company that has historically not borrowed money, why might there be a case for it to borrow more money in its present form? (Think about the trade off on debt and what might have changed at the company)
  2. When Dell borrows the money to buy back equity, what effect will this have on Dell's existing stockholders? What might they have done to protect themselves?
  3. If you can, use the most recent numbers for Dell to compute the optimal debta ratio for the company? Does it back the proposition that Dell can be a highly levered company?
  4. Explain in intuitive terms what it is about having more debt that makes Dell a more valuable company?
  5. When Dell does become a more highly levered company, what are the biggest dangers that it will face?