It looks like Dell Inc. may have to pay up to raise the money for its purchase of EMC Corp.

Barring a major improvement in the bond market, the Round Rock, Texas, firm likely will pay an interest rate in the neighborhood of 10% in coming months to sell as much as $9 billion of unsecured junk bonds backing the acquisition, investors and analysts said.

Soft quarterly results this week at old-guard tech companies such as Intel Corp. and last month's poorly received debt sale by disk-drive maker Western Digital Corp. are building expectations of higher yields for Dell's coming debt issuance, investors and analysts said. The shift stands to add tens of millions of dollars to Dell's annual interest expense, analysts said.

At the same time, Dell's money-losing SecureWorks unit sold 8 million shares Thursday in an initial offering at $14 a share, below expectations.

The developments underscore the increased demands that investors are making on issuers of risky securities following an intense market shakeout between Thanksgiving and the end of February. While Dell has a well-known brand name, rising interest costs stand to squeeze profits at a time when the firm urgently needs to invest to keep up with a changing tech landscape, analysts said.

"People realize there's a transformation that's ahead of us, and people want to get paid for that risk," said Rahim Shad, a senior high-yield debt analyst at Invesco Ltd.

Negotiations between Dell and debt investors aren't expected to happen until after EMC shareholders vote on the takeover proposal, which is anticipated in June. Few on Wall Street expect the deal to face any significant challenge to closing as planned.

Proceeds from asset sales, such as Dell's recent sale of its information-technology-services division to Japan's NTT Data Corp. for about $3 billion, could reduce Dell's borrowing needs, and its junk-bond borrowing needs may also decline if it is able to raise more by selling more of other kinds of debt.

Its flexibility won't be unlimited, however. For instance, issuing a much larger total of secured bonds could jeopardize their investment-grade ratings, necessitating some issuance of unsecured bonds that will receive lower ratings because they aren't collateralized and are more junior in Dell's capital structure. Dell's underwriters include Credit Suisse Group AG, J.P. Morgan Chase & Co., Barclays PLC, Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc., Deutsche Bank AG and Royal Bank of Canada.

The potential cost of issuing debt began to rise for Dell at the end of March, when Western Digital got a chilly reception in issuing $5.2 billion of bonds to fund its acquisition of SanDisk Corp.

Western Digital originally planned to issue $4.1 billion of unsecured bonds, with an interest rate just over 9%. Instead, it was forced to issue just $3.35 billion of unsecured bonds with a 10.5% coupon, increasing the size of its secured debt to make up for the difference, according to S&P Capital IQ LCD. The bonds recently yielded 10.883%, according to MarketAxess, indicating prices have declined. The bonds bear ratings similar to those expected for Dell's unsecured bonds.

While Dell and Western Digital occupy different places in the computer supply chain, the companies have enough in common that the Western Digital deal was closely tracked by investors and bankers as an important gauge of what appetite there may be for Dell debt.

There are ways in which Dell compares favorably with Western Digital, investors said. In general, the company faces less competition, and in acquiring EMC-controlled VMware, would gain ownership of cutting-edge data-center software.

Led by its founder and CEO Michael Dell, who took Dell private in 2013, the company also is expected to make a stronger pitch to investors than Western Digital's management team, investors said.

Still, Dell's leverage, defined as its total debt over earnings before interest, taxes, depreciation and amortization, is anticipated to be markedly higher than Western Digital's after Dell acquires EMC.

Considering that fact, new Dell unsecured bonds could merit a coupon as high as 11% to 12%, investors said. Even if the company can make a favorable impression, it could still be left with an interest rate of around 10%, though market conditions at the time of the debt issuance could move that number up or down, they added.

During an earnings call Wednesday, EMC chief Joe Tucci reaffirmed that the deal with Dell is on track to close within its original May-to-October target window.

In recent weeks several tech companies, including EMC, International Business Machines Corp. and Intel, have reported disappointing first-quarter earnings. Those reports highlight soft demand for computing hardware, as technology spending shifts from corporate data centers to cloud services and from PCs to mobile devices.

Overall, the debt markets are in much better shape than they were just a few months ago, when fears of a global recession all but halted new borrowing by businesses with subinvestment-grade ratings. Average high-yield corporate-bond yields surged in December and January but have since settled down to about the same level, between 7.5% and 8%, where they stood when Dell's deal to acquire EMC was announced in October, according to the Barclays high-yield index.

 

(END) Dow Jones Newswires

April 21, 2016 21:15 ET (01:15 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.
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