Negotiation gurus say that if you think your opponent is foolish or stupid, it may well be you who is out-negotiated. I generally shrug off this type of pop business advice, but when we are talking about Carl C. Icahn, the investor whom I have likened to a Wile E. Coyote, it may be a wise adage.
I raise this after reading Mr. Icahn’s latest announcement to other shareholders of Dell Inc. urging them to start preparing appraisal rights for their shares.
At first blush, the announcement can be charitably described as a Hail Mary pass.
Appraisal rights have gotten a lot of attention in the Dell matter, but as I wrote last week in a post about the endgame for Dell, they are probably not a good option.
That’s because of the way appraisal works and the risks involved. Appraisal is a judicial proceeding in which the court will determine the fair value of the shares seeking appraisal. The idea is to give dissenting shareholders another, potentially more lucrative option than the $13.65-a share that Michael S. Dell and the investment firm Silver Lake are offering.
In Delaware, where Dell is incorporated, appraisal is a process that can take years as the court decides what is the fair value of the shares. It is essentially a battle of the experts. Each side puts financial experts on the stand to testify as to the fair value of Dell shares at the time of the merger. The court then determines the value that the dissenting shareholders get. But most important, the Delaware court can award more or less than the $13.65 being offered to Dell shareholders.
In many Delaware appraisal proceedings, the judge just splits the decision, awarding a value that falls between the experts’ recommendations and giving the shareholders a decent return for exercising their rights.
But the possibility of receiving less would probably be a bigger issue in Dell’s case than in other appraisal proceedings.
The judge in the shareholder litigation over the Dell buyout, who is also likely to hear the appraisal proceedings, Chancellor Leo E. Strine Jr., has already praised the Dell sale process. At a June hearing, he said, “I do not see any plausible, conceivable basis in which to conclude that it is a colorable possibility that you could deem the choices made by this board to be unreasonable with all the different safeguards.†And while appraisal looks at the value of the shares, and not the sale process, it is possible the process used here will affect the judge’s determination. It all means that there is a chance that the court will have an built-in bias against a significantly higher award than the amount being offered right now.
Even beyond that, fair value for appraisal is assessed at the time of the merger, not the time the deal was cut. And since the time this buyout was announced in February, Dell’s business appears to have deteriorated. As a result,Silver Lake and Mr. Dell can also argue that they are actually paying above fair value right now.
So in an appraisal proceeding, Mr. Icahn faces the real possibility of receiving less than $13.65 a share.
And there is another hurdle to appraisal proceedings in the Dell case. Mr. Icahn would not receive his money until the appraisal proceeding was over. The would mean that Mr. Icahn’s money would be tying up about $2 billion in capital for two or more years.
So what kind of return would Mr. Icahn get for tying up billions of dollars?
In a presentation to Dell, Mr. Icahn and his fellow dissident investor, Southeastern Asset Management, stated that the fair value of shares could be about $23 a share. Shareholders are also entitled to interest in any award in an appraisal rights proceeding. The interest rate is the federal discount rate plus 5 percent from the time the merger occurs until the award is paid (5.75 percent in total right now).
If the litigation takes three years, the best Mr. Icahn could make about a 25 to 30 percent annual return. But that is the best-case scenario. If you adjust these figures for the risk of losing, you may be looking at negative returns. This is particularly true when you take into account that Mr. Icahn could have been earning returns with this money.
Mr. Icahn, who is worth about $20 billion, did not become a billionaire by making bad investments. So unless there is a quick settlement, appraisal is probably a bad investment, and no investor intentionally makes bad investments.
In this light, Mr. Icahn’s announcement that he is preparing appraisal rights can be explained three ways:
1. He firmly believes he will win in an appraisal proceeding and thinks that the risk/return is appropriate.
2. He is hoping that enough people seek appraisal to get a quick settlement.
3. He has another strategy in mind, and this announcement is only one part of it.
The first option doesn’t seem likely unless Mr. Icahn is using different numbers.
As for the second possibility, Silver Lake and Mr. Dell are likely to call Mr. Icahn’s bluff and wait out the 60-day period after the merger â€" the period during which Dell shareholders are able to change their minds about whether to seek appraisal. Then, Mr. Dell and Silver Lake will negotiate with whomever is left. Why would Mr. Dell and Silverlake negotiate before the end of the 60 days? They might as well wait. Mr. Icahn talks about “getting lucky†by exercising your appraisal rights, but you may have a better chance of victory at the slots in Las Vegas.
In addition, Mr. Icahn stated in his announcement that if enough Dell shareholders dissent, the lenders on the deal might try to back out by claiming that the material adverse change clause in their lending agreement was triggered. This clause generally provides an out for the lenders if something material and adverse happens to Dell. But a MAC clause is difficult to invoke and must be unexpected and unanticipated. Appraisal rights are a wholly expected outcome of a merger, and so it is hard to see how their exercise could trigger the MAC clause.
So while Mr. Icahn mentioned the possibility, it is unlikely to work.
This leaves Option 3, and here we have that negotiating principle I wrote of at the beginning.
Assuming that Mr. Icahn is doing the same math, he knows this is a gambit. In this case though, perhaps he is trying to throw everything up against the wall. But, perhaps, there is an alternate explanation. To exercise appraisal you have to vote no for the deal, and notify Dell before the vote occurs. By preparing appraisal rights, Mr. Icahn may be making a Hail Mary pass, but one aimed at signaling “no†votes before the actual shareholder vote. Perhaps he is merely trying to show that he has a bigger block of “no†votes than Mr. Dell and Silver Lake think. It’s a small bargaining chip, but at this point everything counts.
Still this is pure speculation, and Mr. Icahn’s options don’t look particularly appealing, no matter the explanation for his latest action. Nonetheless, it never pays to underestimate Carl Icahn.
