Yesterday, I took a position in my own account which I will share with you. I took a long in DVMT and an equal amount short in VMW. To give you some background, in 2015 Dell acquired EMC Corp which had an 81% position in VMware (VMW). To help pay for the acquisition they created a tracking stock (a spin-off would have resulted in a large amount of tax because of EMC’s low cost) which would track the underlying economic interest in VMW. To read more see WSJ’s article or the merger doc. As a result EMC shareholders received $24.05 in cash and 0.111 shares of Dell Technologies Inc. – V Share Class (DVMT). The economic interest in VMW is shared by a) public float (19%), b) DVMT tracker (53%) and Dell (28%).
Tracking stocks have been used by several companies such as Disney (DIS), General Motors (GM), Liberty Media, AT&T and others. These stocks in general follow the underlying stock and trade at a discount because they are not a direct ownership of the underlying company. Also many investors don’t like this type of financial engineering.
The truth is that DVMT is riskier than VMW because it was issued by Dell and if Dell goes bankrupt then you get nothing. Dell though has been reducing its debt. In 2Q it did so by $9.5 billion, but there is still $49.9 billion in total debt left. The company’s last twelve months adjusted EBITDA was $7.9 billion for a debt/EBITDA of 6.3x. If we exclude Dell Financial Services (DFS) debt then ‘core debt’ is $40.5 for a core debt/EBITDA of 5.1x. (Link to 2Q releases and presentations). That’s still very high in my opinion so there is risk in owning DVMT.
The tracking stock trades at a 34% discount. This is much higher than other tracking stocks which have traded in the teens. Furthermore if we look at the chart below, we see that the stock traded at a 27% discount this summer.
A long-short is essentially a bet that the discount will narrow, however that is not the only angle someone could play. If someone is a bull on VMW then they can buy VMW at a discount and take a long position via DVMT instead of VMW. Personally I don’t find either cheap enough for a long and hence I’ve gone with the long-short for the discount to narrow. Of course it’s important that your broker has VMW shares and you can borrow cheaply in order to do this trade. I estimate that if it returns to the path it was previously on and narrows to just 27% then I can make 10% on this trade and 20% if it narrows to a 20% discount. Even, Michael Dell sees value in this as he is buying back shares in the open market as shown below (link). Note that due to the tax consequences a spin-off of VMW shares to holders of DVMT can’t occur until 2021.
