The pending buyout of EMC Corp. (NYSE: EMC) by the now-private Dell Inc. already is facing problems. Now new concerns about the would-be merger may be growing, and they are not just concerns about how VMware Inc. (NYSE: VMW) is being treated like an unwanted step child in this merger.
Wells Fargo has decided to downgrade EMC to Market Perform from Outperform, and the firm’s Maynard Um also lowered his fair market valuation range to $25 to $28 from the prior range of $29 to $30.
The downgrade was driven by a significant challenge in valuing the proposed tracking stock for VMware that was proposed by Dell, and over uncertainties around whether the deal could be complicated or derailed by potential tax issues. Wells Fargo’s report said:
The complexity of this deal and the measurement of the outcomes makes this event challenging and we fear disruption, in the interim, could have an adverse impact on business. While we think there are still a number of potential outcomes, each could have differing impacts on EMC’s share price. Ironically, we think if EMC had planned to execute some of Dell’s reported plans such as selling off assets or spinning off Pivotal in early 2016, investors would have reacted favorably. The ideal scenario, in our view, would have been these actions combined with a buy-in of VMware.
More specifics on VMware were described as follows:
While VMware provides a publicly traded comp for the proposed tracking stock, after further analysis, we find it difficult to come to a definitive value for the tracking stock (we initially assumed a 10% discount to the publicly traded entity though VMW shares are down 23.2% (S&P up 3.6%) since the announcement) and, thus, struggle to value this as the best proposed deal for shareholders. Until there is better clarity to the value of the tracking stock and/or deal closing, we believe it prudent to lower our rating.
While this downgrade has caution, there are also some positives. There could still be a wide range of potential outcomes here that could go either way. That potential $9 billion tax bill might not come and might be mitigated. EMC’s new range implies 10 times to 11 times projected 2016 free cash flow. And also, EMC likely will benefit from having built a strong portfolio of assets in key areas of future industry growth. The company also has potential strategic actions, and an improvement in fundamentals would drive shareholder value.
EMC shares have drifted lower in recent days. In fact, EMC shares at $26.35 on November 2 has come with six consecutive days of lower share prices, down to $25.17 Wednesday morning.