Dell’s LBO debt to dampen M&A deals, Moody’s says

The bid to take the Round Rock, Texas-based technology firm private will require gross reported debt of about $18 billion, or six times debt to EBITDA, with founder and CEO Michael Dell in line to own 75 percent of the company and Silver Lake 25 percent.

Without having to pay an average of $1.4 billion in share buybacks per year and a “more tempered” approach to mergers and acquisitions, “Dell will have ample cash flow that can be used for debt service,” Moody’s said.

Moody’s said it expects Dell’s PC revenue to continue to erode in 2014 in the low single digits, even as its increased debt burden will limit the company’s financial flexibility.

“While Moody’s believes that Dell is building sufficient sales, product and R&D scale in its enterprise segments following a series of acquisitions, Dell will have to complete the transition mostly organically,” the debt rating agency said in a prepared statement. “The risk exists that additional funding will be required for Dell to expand its technology footprint to remain competitive against peers with superior liquidity and credit profile.”

Moody’s projects Dell will wring out cost savings of more than $2.5 billion, which may be reinvested in the business through research and development or marketing incentives. Dell Inc will likely channel part of an estimated $2 billion in annual cash flow toward debt reduction.

The research firm said Dell may cut its debt level to less than $16 billion by Jan. 31, 2015.

Silver Lake will have certain consent rights for significant cash outlays, Moody’s said.

“Moody’s could upgrade Dell’s ratings if the company were to show sustained revenue growth in the low single digits, operating margins greater than 6 percent, free cash flow in excess of $2.5 billion, and gross debt to EBITDA below 3.5 times,” Moody’s said. “The rating could be lowered with sustained erosion of market share, reported operating profit margins lower than 2.5 percent, or contraction of the PC market faster than anticipated.”

Specifically, Moody’s assigned Ba3 Corporate Family (CF) and Ba3-PD Probably of Default ratings to Dell Inc, the parent of Dell International LLC. Moody’s also rated Dell International LLC’s senior secured term loans and first lien notes as a Ba2 and its second lien notes as a Ba3. Upon closing of the debt financing, existing unsecured notes held at Dell Inc will be downgraded to B1 from Baa1. The rating outlook is stable.