Back to main

Should You Sell Dell Now?

Posted
1/16/2013 10:09:00 AM
By: OptionsANIMAL
Referenced Stocks:DELL

By Greg Jensen

The market has been all worked up about reports that Dell (DELL) may be taken private. The stock jumped on the news (or is it rumor?) but is retracing a little from highs as I write. It is possible that you read this piece back in November, took my advice, and were already long DELL. If so, congratulations, but should you ride the wave or sell now?

 

The 6-month chart above shows the extent to which the stock has recovered from those November lows but obviously, with news of a possible deal breaking, technical analysis is of little use. It would appear that the chances of a deal, and if so at what price, are the most important questions here.

One thing is evident. The chances of a deal are lower now than they were on Friday, and probably much lower than they were when the reported talks started. At around $9.00 DELL looked cheap; at over $12.00, not so much. Of course there are other factors that affect the viability of a proposed leveraged buyout (LBO) for a private equity firm, including cash flow to service the debt that will be taken on and the value of separate pieces of the company. It may yet happen, given these criteria, but if you own the stock you should be asking a different question. If the deal falls through, what happens then?

The only logical answer is a collapse in the stock price. Not just to the levels before the news but maybe back to those November lows or beyond. Rumor based optimism is a fragile thing. The market can be expected to overreact to the bad news, just as it probably has to the good.

Whether you did pick up stock near the bottom or have been hanging on, watching the fall and waiting for a chance to cut, there are lessons to be learned about how to judge a position after a significant move. Where you own it is no longer relevant. It now becomes a new risk/reward calculation. Now that word of the talks is out, things have changed. The price of DELL has risen significantly, around 30% from those November lows. Assuming that, as reported, talks got serious at the end of last year, it is reasonable to assume that that was because of valuation. It certainly wasn’t as a result of better earnings. That valuation dynamic has now changed, naturally limiting the upside from here, while increasing the potential downside.

If you believe me that lack of a deal would see a drop back to around $9, then we are looking at a downside of around 28%, based on a current price around $12.60. The same percentage to the upside would give a tender price of over $16.00. I guess that is possible but, given around a 50% chance of a deal being worked out, that results in a coin flip. Contrary to the popular misconception, successful investors and traders are not usually die-hard gamblers. They look for situations where the odds are in their favor, rather than just hoping for the best.

If you agreed with me in November, you weren’t looking for a sudden surge in the price of DELL. You were looking for a gradual improvement in earnings and outlook. Back then, you probably would have taken a 30% profit. You should take it now.