NEW YORK (Reuters) - As a young investment banker in the 1990s, Harry You learned about an obscure General Motors Co (GM.N) security called a ‘tracking stock.’ As an EMC Corp EMC.N executive working on selling the data storage company to Dell Inc, he helped revive it.
The addition of a tracking stock for VMware, a software maker majority-owned by EMC, is a critical part of Dell’s $67 billion deal for EMC struck on Monday, the biggest technology acquisition ever if it goes ahead.
Tracking stocks allow stockholders to benefit from the performance of a specific unit of a publicly traded company, without giving away any ownership or control. At the same time, investors lose money if it falters, a potential concern if VMware’s shares continue to fall over the next seven to 12 months as the deal is finalized.
Harry You, an executive vice president in charge of EMC’s corporate strategy, was instrumental in devising the structure that helped Dell afford the massive acquisition, according to people familiar with the matter who were not authorized to discuss the deliberations.
You, a former Oracle Corp (ORCL.N) Chief Financial Officer, brainstormed with Egon Durban, managing partner of Silver Lake, the private equity firm that is an investor in Dell, and other senior executives for close to a year to put together the plan that would allow heavily indebted Dell to finance its offer.
They came up with a stock that tracks the value of VMware Inc VM.N, the virtualization software company in which EMC has an 81 percent stake. Revenues of VMware, focused on cloud-based services, are growing much faster than EMC as a whole.
The tracking stock helped boost Dell’s $24.05 per share cash offer for EMC, bringing it to $33.15 based on the value of the shares before the market opened on Monday.
While the tracking stock helped pay for the deal, it also introduced uncertainty to it. VMware common shares ended trading on Monday down 8.1 percent, and slid further on Tuesday on concerns the market could be flooded with tracking shares of EMC shareholders looking to offload them, and fears Dell itself may sell more shares to lighten its debt load.
Dell will have $49.5 billion in debt under current plans to finance the EMC deal.
EMC shares closed at $27.55 on Tuesday, below the estimated offer value of around $31.80 per share, suggesting investors were pricing in some risk into the merger.
“I think people do not understand how the tracking stock works, (their use for companies with traded common stock) is a relatively new phenomenon in the market place. We will have to spend a lot more time with our shareholders explaining what is going on with the tracking stock,” David Goulden, Chief Executive of EMC Information Infrastructure, the company’s biggest division, told Reuters in an interview.
General Motors was the first U.S. company to issue a tracking stock when it acquired Electronic Data Systems in 1984 from Ross Perot, better known years after as a U.S. Presidential candidate. You, 55, who worked as an investment banker at Salomon Brothers, Lehman Brothers and Morgan Stanley (MS.N), advised on transactions on which General Motors used tracking stock as currency.
You did not offer any comment when contacted by Reuters.
Tracking stocks reached their peak of popularity at the end of 1990s and then lost much of their allure with the bursting of the dot-com bubble. They were used mostly to reflect the value of divisions that companies, many of them in the technology sector, did not want to have publicly listed.
To be sure, tracking stocks are still in use by a few companies. Liberty Media Corp LMCA.O Chairman John Malone, for example, used them in 2012 to separate the home shopping services assets of Liberty Interactive Corp (QVCA.O) from its digital media assets.
VMware is an EMC subsidiary that is already publicly listed. EMC did not want to relinquish control of the unit because it complements EMC’s other businesses and has the potential to work well with Dell. Activist investor Elliott Management called on EMC to spin off its stake in VMware last year, only to be rebuffed.
EMC shareholders are to receive tracking shares representing 53 percent of the total economic interest of VMware. These shares have no voting rights and would only pay a dividend at the behest of Dell’s board. VMware, under EMC’s control, does not currently pay any dividends, and so the companies argue that the tracking stock should trade in line with the common stock.
“What they should have done was build a collar around VMware. They could have structured it whereby if VMware falls below $75 per share, the value of the tracking stock goes up proportionately. Right now, there is no downside protection,” said Macquarie analyst Rajesh Ghai.
VMware shares closed at $69.31 on Tuesday. They traded as high as $82.25 last week, before any public talk of the Dell deal.
EMC shareholders will be called upon to vote on the deal with Dell in the new year, provided a 60-day ‘go-shop’ period does not result in a higher offer, which most industry experts consider unlikely.
Proxy solicitors said it was too early to judge how EMC shareholders will value the VMware tracking stock by then. Investors will be looking to see whether the recent overhang in the common stock of VMware is removed in the coming months. “The big question is how do other shareholders other than Elliott feel about this deal. They are just going to have to do the evaluation,” said a person who worked on the proxy vote solicitation during Dell Chief Executive Michael Dell’s move to take his computer maker private for $24.9 billion two years ago.
Reporting by Liana B. Baker and Michael Flaherty; Editing by Greg Roumeliotis and Bill Rigby