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3Par’s lease cancellation option and the HP vs Dell bidding war August 24, 2010

Posted by Bob Cook in Company Case Studies, Corporate HQ, Financial Planning & Analysis, M & A Integration, Silicon Valley.
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Update 9/3/2010:  It appears that the bidding war for 3Par did happen.  After a number of volleys, it looks like HP is the winner.  Yesterday, 3Par accepted its latest offer, and Dell said it is withdrawing from the bidding.

According to the San Jose Mercury News, here’s how the bidding went:

Aug 16:  Dell and 3Par announce they have an agreement for Dell to acquire 3Par at $18 a share.

Aug 23:  Before the stock market opens, HP announces competing offer to acquire 3Par at $24 a share.

Aug 26:  3Par announces in the morning that Dell has countered at $24.30; HP raises to $27 after the market closes in the afternoon.

Aug 27:  3Par announces before the market opens that Dell has raised its bid to $27 and HP goes to $30 two hours later.

Sept 2:  3Par announces before the market opens that Dell has raised to $32 and that HP has countered at $33. Dell announces it’s withdrawing from the bidding an hour later.

Update 8/26/2010:  Yesterday, Dell matched HP’s offer for 3Par and 3Par has accepted it.  This does not preclude HP from making another bid, but reportedly there is a $72-million termination penalty that 3Par would have to pay if it didn’t close with Dell.  

It’s good entertainment watching the bidding for 3Par.  Dell offered $1.1 billion .. a full 87% premium over 3Par’s pre-offer market cap … and it looked like a “go” … until HP, yesterday, offered $1.6 billion.  Dell, reportedly, is preparing another offer.  It has quite a deficit to overcome … $400 million … but if it matches or betters HP’s offer, we might see an exciting bidding war. 

How the two companies perceive the overall value of 3Par is, of course, based on how 3Par’s product lines, technology, and talent could add value to their respective companies. When, however,  it comes down to the short strokes… when the increments between the bids are in the neighborhood of $100 million, $50 million, or even $10 million or less … that’s when those leading the acquisition teams will be looking for the not-so-obvious elements of value hidden in 3Par.  

When they look at the real estate … and they need look no further than 3Par’s 10-k … they’ll find a nugget.  3Par’s annual operating lease expense is about $2.5 milliion, but mostly from its 263,000-square-foot headquarters in Fremont CA (in Silicon Valley) for which it has the right to cancel the lease as of May 2011, albeit with a $1 million cancellation fee.  If the acquirer can move the 3Par operation to property they already have (and which is difficult to dispose given the depressed real estate markets), there’s hidden value in that right to cancel.

It looks like 3Par … when it amended the lease to include the cancellation provision … may have already been thinking about how it might look to a potential purchaser.  And it had good reason to think that a suitor might be from nearby …  with the acquisition-minded likes of  HP, Intel, Oracle, and Cisco all headquartered in Silicon Valley.

So, could the presence of this cancellation provision determine who wins the bidding war?  Maybe.  It depends on how short are the short strokes.

While it is difficult to estimate the extra value that could be garnered from eliminating some of 3Par’s real estate overhead, it is clear that the cancellation option most likely has more value to HP, which has lots of real estate in Silicon Valley where it is headquartered, than to Dell which is headquartered in Texas. 

As to how much value could be gained.. here’s my stab at quantifying it:  The annual expense that could be saved by eliminating the lease looks to  be on the order of $2 million.  There would be other savings to be had, though, from consolidating 3Par operations into the acquirer’s operations. Using a (very imperfect) rule-of-thumb for the  cost of housing an employee of around $10,000 per year … and assuming that most of 3Par’s 668 employees are at headquarters, the potential savings could be close to $6 million per year.  That savings would be eroded away by the costs of retrofitting space to accommodate 3Par and by the migration of some expenses (such as utillities) with the people, but a reasonable estimate of the annual savings possible from integrating 3Par into the acquirer’s facilities might be about $3 million, on a pre-tax basis.. That’s about $2 million, after-tax, virtually all of which would flow to the bottom line.  At a p/e ratio of, say, 10, that savings would be worth $20 million to shareholders.  Not a big number relative to the overall offer price of $1.5 billion, but maybe enough on-the-margin to help win the bid.  Depends on how short are the short strokes.

Addendum 8/26/2010:  Maybe the short stroke is the $72-million cancellation penalty.

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Comments»

1. Mike Giles - August 25, 2010

Bob, I really enjoy reading your insights. They help to lift me from the myopic day-to-day grind of my local market. Thanks!

2. Anonymous - August 28, 2010

Thank you for putting a real estate analysis on this issue.

3. David Mirmelli - August 31, 2010

Thanks for sharing.


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