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Table of Contents
1 2 3 4 Case Summary....................................................................................................................................... 2 Identification of Problems .................................................................................................................... 2 Theories to Solve problems .................................................................................................................. 2 List of alternative Solutions to the Problem ......................................................................................... 3 4.1 4.2 4.3 4.4 Do Nothing .................................................................................................................................... 3 Unload All VERITAS Stake.............................................................................................................. 3 Sell to other Investors ................................................................................................................... 3 Vertical Integration ....................................................................................................................... 3 Advantages............................................................................................................................ 4 Disadvantages ....................................................................................................................... 4
Analysis and Identification of the Right Alternative ............................................................................. 4 5.1 5.2 Capital Structure for the LBO ........................................................................................................ 4 Payback Period .............................................................................................................................. 5
Findings and Recommendation ............................................................................................................ 5 6.1 Findings ......................................................................................................................................... 5 LBO Price ............................................................................................................................... 5 Cost of Capital Calculation .................................................................................................... 5
Recommendations ........................................................................................................................ 6
1 Case Summary
Founded in 1979, Seagate Technology, Inc. was the market leading manufacturer of computer hard drives, owning 21.1% of the total disk drive market in 1999, an industry where six companies account for 95% of sales. Seagate also had the largest market share of the Enterprise (41%) and Desktop (21.1%) disk drive market sectors in 1999. In May 1999, Seagate sold its Network & Storage Management Group to VERITAS Software Corporation, an independent manufacturer of storage management systems, for approximately 155 million shares of VERITAS stock. With an ownership stake of over 40%, Seagate became VERITAS' largest stockholder. From June 1999 through November 1999, Seagate's stock price increased by 25%, while VERITAS' stock price increased by over 200%. This resulted in occurrences of Seagate's stake in VERITAS exceeding the entire market value of Seagate's equity, essentially assigning a negative value to Seagate's large and market-leading disk drive business. Seagate Technology Inc. was in need of a major restructuring proposal. President and CEO of Seagate, Stephen Luczo, met with Silver Lake Partners L.P a private equity firm to discuss the options for the proposal. After much debating, the best option seemed to fall into two stages, a leveraged buyout of Seagates disk drive operations, followed by the tax-free acquisition of Seagates remaining assets by VERTIAS Software Corporation.
2 Identification of Problems
1) How can Seagate address the companys low stock price? 2) How should the buyout be financed? What should the capital structure look like? 3) How much should investors pay to acquire Seagates Disk drive operations? 4) How can Seagate address VERITAS Software Corporations needs and concerns?
distributed to them, but want to invest the proceeds of selling these shares elsewhere. Mostly managers of private equity funds prefer to sell rather than distribute shares 4. Private equity returns can be attributed to a large extent to financial manoeuvring rather than managerial skills. Increasing leverage of the acquired firm by adding debt and paying out the proceeds from the debt offering to the private equity funds is a popular method for achieving a fast payout
4.4.1 4.4.2
Advantages Smaller inventories Control over development of cutting-edge technologies in its products More control over the manufacturing process, which gives the company the ability to increase production in times of high demand o Gives Seagate a competitive advantage Disadvantages Higher fixed costs that do not change with sales Inability in a downturn to pay fixed costs Low support from financial analysts
According to the estimates from S&P, Debt as % of total capital comes around to be 23.3% for BBB Rated firms. However considering the uncertain demand, very short product life-cycle for Disk drive business, we believe that it is considerably riskier business as compared to a normal business. We therefore propose a conservative capital structure of 20% Debt and 80% Equity for the LBO transaction.
The initial equity required to be put by the Silver Lake group is around $944 Mn. As per the forecasted cash flows for Seagate, this points to a payback of 3 Years and 11 Months.
91.1 821.72
60.7
130.6
167.3
337.3
406.2
456.8
NPV for the Upside Case Taking simple average of the two cases, the NPV comes out to be $1180Mn. This is the price of LBO; Silver Lake must pay to acquire Seagate Technology Inc. 6.1.2 Cost of Capital Calculation
Calculation of cost of Capital Risk Free Rate(30 Yr. Govt Security) Equity Beta Market Risk Premium(As given by Prof. Damodaran for Mature market of U.S Cost of equity 5.84% 1.2 8.60% 16.2%
Cost of Debt (For Seagate's Rating of BBB) Tax Rate Debt Market Capitalization of Equity Total Capital D/V E/V WACC Morgan Stanley has used a WACC of 15% as per the case
6.2 Recommendations
Seagate should go ahead and sell its Disk drive business through the LBO deal to Silver Lake. It offers the best possible solution for Seagate, to get rid of the potentially huge tax liability of selling VERITAS shares and generate enough funds from the sell-off to capture future growth with the additional flexibility that would come by going private. Seagate has a sound business and is the market leader in the Disk Drives segment, and we believe that the additional funds generated from the sell-off, would help Seagate streamline existing processes, and further vertically integrate into the value chain. The deal is also beneficial for Silver Lake LP as they are generating a handsome return with a payback in 3 Years and 11 months