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Why Investors Are Stoked About the Dell Buyout

Buyout deals don't always produce great companies, but they do tend to excite investors, with the stock market typically rising when big deals are announced.

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That seems to be the effect of the Dell buyout on the broader stock market. Under the complex deal, a group consisting of company founder Michael Dell, Silver Lake Partners and others will buy the publicly traded company at $13.65 per share. By going private, Dell hopes to have more flexibility in its business strategy than if under the constant scrutiny of Wall Street analysts and activist shareholders.

The buyout is actually a sign of Dell's struggles, as consumers shun the company's PCs in favor of tablets, smartphones and other devices made by competitors. But many investors see it as a sign of strength in the financial markets, since the $24.4 billion deal is the biggest since 2007, before the financial crisis. The S&P 500 stock index rose by a full percentage point the day the deal was formally announced.

Dell shareholders will profit from the buyout, but more importantly, such deals tend to reflect the smart money's confidence in the future and willingness to take risks. That's what famed British economist John Maynard Keynes meant when he referred to the "animal spirits" that drive markets up. "Investors are betting on a strong recovery when they make these types of deals," says Colin Claydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth University's Tuck School of Business. "They assume they'll be able to make Dell a better competitor in markets that are strengthening."

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The Dell deal involves a fund put together by Silver Lake, a Silicon-Valley private-equity firm that counts pension funds, university endowments and other big investors among its clients. The willingness of conservative institutional investors to commit money to such a deal indicates a firm belief that financial markets are stable and healthy.

Even more telling is the ability of the group to raise debt financing from blue-chip Wall Street firms such as Bank of America, Barclays and Credit Suisse. Microsoft is also kicking in $2 billion. "It means the debt markets are back," says Blaydon. "This is what has been missing since the financial crisis."

Ordinary consumers may associate leveraged buyouts with go-go markets and Wall Street cowboys. And LBOs, as they become known in the 1980s, may generate more layoffs than jobs, since they often involve bloated or trouble firms that need to be restructured.

But buyouts, along with mergers and acquisitions, are a vital element of capitalist economies because they provide ways for companies and sometimes entire industries to become more efficient. In deals such as the Dell buyout, investors clearly think they can earn a higher return on their money through an LBO than they could by parking it in safe, fixed-income investments. That will persuade others to invest--lest they miss out--generating more economic activity and most likely, rising stock prices.

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Dell may emerge from the deal as a more competitive company. The fact that Michael Dell is involved suggests there's much more to the buyout than stripping the firm of assets and selling them off. The most likely outcome, in fact, is a public offering in a few years, after unproductive business lines have been shut down and more promising ventures expanded. For the investors to make a profit, the stock market will have to be healthy four or five years from now. They're betting it will be.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback to Success. Follow him on Twitter: @rickjnewman.

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