Dell Buyout Battle: Why The Icahn-Southeastern Plan Flopped At I.S.S.

Knowing that time is truly money in most situations, an influential proxy adviser this morning dealt a significant blow to the activist investors working to scuttle the $24.4 billion management-led buyout of Dell .

Institutional Shareholder Service gave its stamp of approval to the management buyout rather than to the activist group led by hedge fund titan Carl Icahn and Southeastern Asset Management. In all, I.S.S. criticized the leveraged recapitalization idea that the activists suggested as too uncertain, and too lengthy, an idea to support.

Had I.S.S. thrown its weight behind Icahn and Southeastern, advising investors to vote against the buyout proposal ($13.65 a share) from CEO Michael Dell and private equity firm Silver Lake Partners, a complex, multi-step situation would've followed.

After nixing the buyout, investors would next need to oust the Dell board--and the billionaire founder from the top job. To I.S.S.'s thinking, that would waste time--something that Dell cannot spare in its turnaround efforts--and risk not happening at all. An investor saying no to $13.65 a share might not necessarily also want to boot Michael Dell, since as I.S.S. points out: "This is, after all, the same board and management team which developed the transformation strategy these shareholders bought into, and which, even Southeastern appears to argue, has been executing well on that strategy."

With the board replaced under the Icahn-Southeastern plan, the newly installed directors would make a $14-a-share-cash tender offer for up to 72% of Dell stock. The buyback would allow unhappy investors to cash out, while increasing the ownership stakes of investors who stick around. However, if the tender offer was oversubscribed, it would become a cash-and-stock deal, meaning some investors wouldn't be able to exit as they hoped.

A protracted process indeed.

What happens next? A vote on the buyout proposal comes later this month, and the I.S.S. decision drives a substantial nail (or three) into the coffin for Icahn and Southeastern. While the activists are among the largest shareholders behind Michael Dell, they likely will not have enough support to scrap the management buyout. Other active-management shops like Pzena Investment Management and Yacktman Asset Management joined Icahn and Southeastern. So did T. Rowe Price. But for Icahn and Southeastern to win, they needed all the passive exchange-traded funds and index-hugging mutual funds that own Dell shares to vote with them, and those types of investors typically rely solely on the analysis proxy advisers like I.S.S. and Glass Lewis to make their decision.

It's worth noting that I.S.S. casts doubt on the Icahn-Southeastern idea for its drawn-out nature rather than many of the criticisms that Dell made in efforts to dismiss the alternative. Dell says the activists' plan would load on too much debt. I.S.S., on the other hand, wasn't bothered by the debt. It calculated that the leveraged recap would take Dell's debt-to-earnings before interest, taxes, amortization and depreciation (EBITDA) ratio to 1.7. I.S.S. calculations shows that major Dell competitors have similar debt levels. IBM and Hewlett-Packard would actually have lower debt-to-EBITDA ratios (0.8 and 1 respectively),  while Cisco, Oracle and EMC and NetApp would have ratios close to or higher than Dell (between 1 and 3).

Another past issue has been how Icahn will fund the deal. The Dell directors say Icahn is miscalculating--and that he's billions of dollars short of what he needs. I.S.S. doesn't see it that way, though it does point out that for Icahn to dip into the company's cash reserve and sell its receivables, he would first need to recast the board.

Taken all together, I.S.S. couldn't see the benefits of such an extended process. Not for just 35 cents a share more than the management buyout.

Reach Abram Brown at abrown@forbes.com.