GMP – Tata Steel (2019-20)

Sealed Air Corporation’s Leveraged

Recapitalization

Team Members
CGT19003: Anil Kumar Nayak
CGT19004: Animesh Kumar Singh
CGT19005: Ankit Bansal
CGT19009: Bhavani Shankar
1|Page GMP – Tata Steel (2019-20)

Contents
Introduction ............................................................................................................................................. 2
Top 5 Financial Problems with the case ................................................................................................. 3
1. Leveraged Recapitalization vs Leveraged Buyout ...................................................................... 3
2. No Credit History for Sealed Air Corporation ............................................................................ 3
3. Agency Problem.......................................................................................................................... 3
4. Negative Net Worth .................................................................................................................... 3
5. Change in clientele or Investor base ........................................................................................... 4
Analysis .................................................................................................................................................. 4
1. Rationale behind recapitalization: ............................................................................................... 4
2. Value created for shareholders .................................................................................................... 5
3. Analysing key financial ratios before & after recapitalisation .................................................... 6
4. Other impacts of recapitalization ................................................................................................ 7
Summary and Conclusion ....................................................................................................................... 7

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)
2|Page GMP – Tata Steel (2019-20)

Introduction

Less than a year after Sealed Air embarked on a program to improve manufacturing
efficiency and product quality, the company borrowed almost 90% of the market value
of its common stock and paid it out as a special dividend to shareholders. Management
purposefully and successfully used the leveraged recapitalization as a watershed event,
creating a crisis that disrupted the status quo and promoted internal change, which
included establishing a new objective, changing compensation systems, and
reorganizing manufacturing and capital budgeting processes.
Sealed Air's stock was "undervalued" because the company was generating "free cash
flow". Free flow more than that required to fund cash all the company's positive net
present value investment opportunities tempts companies to waste money. Prior to the
recap the company had over $50 million in cash and short-term investments and Dermot
Dunphy, CEO, expected cash on hand to more than double over the next year and a
half. Pete Fankhauser, Senior Vice President, described problem of excess cash flow at
Sealed Air, "We didn't need to manufacture efficiently, we didn't need to worry about
cash. At Sealed Air, capital tended to have limited value attached to it - cash was
perceived as being free and abundant."
Management considered many alternatives uses for the company's cash. Among them
were launching a capital expenditure program, buying another company, increasing the
regular dividend, or starting to manage a portfolio of securities. There were no good
acquisitions available and they had nothing to do with the cash.
Dunphy felt strongly that his job was not to be a portfolio manager, nor did he want to
waste shareholders' money on a second-rate acquisition. He decided not only to pay out
the cash on hand, but to borrow against the company's future cash flows and pay the
$40 special dividend. Dunphy felt the market was "substantially undervaluing" the
company's stock and seriously considered paying out almost the entire stock price - to
demonstrate that there was excess value to be realized.
Many shareholders felt this leverage would make the company riskier. Moreover, the
banks had a negative reaction. First, management, as shareholders, would receive a
substantial pay-out. Second, the company would end up with negative net worth. Many
banks could not get a deal with negative net worth past the loan committee.
Despite these problems, Sealed Air managed to finance the special dividend. Banker's
Trust led a syndicate that loaned under a secured bank credit agreement. The loan
imposed some stringent constraints on the company, including severe limitations on
capital expenditures. The company also issued $170 million in subordinated bridge
notes which were later refinanced with a public offering of senior subordinated notes.
The remainder amount came from dividend company received from it subsidiaries &
cash.

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)
3|Page GMP – Tata Steel (2019-20)

Top 5 Financial Problems with the case

1. Leveraged Recapitalization vs Leveraged Buyout

Leveraged recapitalizations have a similar structure to that employed in leveraged

buyouts (LBO), to the extent that they significantly increase financial leverage.
However, Recapitalization use the leverage to give dividends to shareholders while
Buyouts uses the leverage to buyback equity. Shareholders are less likely to be impacted
by leveraged recapitalizations as compared to new stock issuances because issuing new
stocks can dilute the value of existing shares, while borrowing money does not. For this
reason, leveraged recapitalizations are looked upon more favorably by shareholders.
As the CEO Dunphy describes “If we had done this as an LBO, it would have put the
company into play and forced us to leverage to the wall. The special dividend did not
put the company into play.” Also, company wanted to keep shareholders interest as its
top priority. To increase the leverage recapitalization was the best possible option.

2. No Credit History for Sealed Air Corporation

Cash flows from operations were significant for their operations and expansions. The
firm had debt to equity ratio of the firm was very low ~8%. This was not perceived well
by the banks while considering the such a large amount of loan. “The banks told us that
we could not borrow the amount that we needed because we didn’t have a track record
for managing large amount of debt. You can’t borrow money unless you’ve borrowed
money.” This was creating difficulty for Sealed Air to secure the required loan.

3. Agency Problem

As usual, a large number of shares were held by the top management of the company.
Paying such a hefty dividend would put the top management’s commitment in question.
This action could be perceived as action motivated by self-interest. This was creating
problem for Sealed Air to raise capitals from Bank.

4. Negative Net Worth

The proposed leverage amount would have pushed companies net present worth to a
negative value. This could have wide implications ranging from hurting investor

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)
4|Page GMP – Tata Steel (2019-20)

segments, having difficulty in raising any additional capital to being prone to

acquisition. Due to negative net worth Sealed Air faced difficulties in securing the loan
“A lot of banks can’t get a deal with negative net worth past the loan committee”. Also,
there was shift by some institutional investors who were averse of negative net worth
of company

5. Change in clientele or Investor base

Prior to the recapitalization Sealed Air's stocks were held by institutional investors who
were looking for a steady growth company with solid financials and limited risk. After
the recapitalization, many of the institutional investment funds had to, or chose to, sell
because of the rules or guidelines they had in place for their clients, such as: market
capitalization more than certain levels, requiring stocks to pay dividends, leverage
levels, deficit net worth. The new investors are more speculative, looking for significant
profits. This in turn has created a situation where the managers may now be looking at
the current month or quarter instead of the long-term forecasts for the company's future.
Also, the new policy in employee’s stock ownership contributes to this change in
investor base.

Analysis

We have tried to analyse Sealed Air Corporation’s recapitalization initiative in

following ways:
1. Rationale behind leveraged recapitalization
2. Stockholder value created by recapitalization
3. Analyzing key financial ratios before & after recapitalisation
4. Other impacts of recapitalization

1. Rationale behind recapitalization:

1) The company looked at potential acquisitions as it was customary for the company
in the past to use excess cash for M&A activity. At the time of the leveraged
recapitalization, no other promising acquisitions existed. Furthermore, previous
acquisitions failed to inspire or reinvigorate the product line or workforce. With the
newly leveraged structure, the company would have to undergo much greater
scrutiny prior to any new acquisitions versus before when the goal may have been
to simply grow.

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)
5|Page GMP – Tata Steel (2019-20)

2) The excess cash allowed management to remain complacent regarding innovative

production techniques, as it gave the false sense of security and growth for the
company. While the World Class Manufacturing initiative provided some
manufacturers to become more efficient, the management ultimately feared having
too much cash on the balance sheet would not continue to force manufacturers to
constantly conceive of new and innovative ways to keep lean. Having a leaner
balance sheet keeps the company leaner from a psychological and an employee
morale standpoint. At an extreme level, excess cash can lead to agency costs as in a
bloated cash flow can result in gratuitous expenses such as corporate jets,
unnecessary conference travel, and other unproductive wasteful spending.

3) Holding onto the excess cash wasn’t in the best interest of the shareholders. After
all, if the cash isn’t being used to invest in profitable projects within the company,
it should be returned to the shareholders to allow them to invest in other
opportunities. Simply put, the company felt it didn’t need the extra cash to invest in
positively yielding projects or fiscally beneficial acquisitions and wanted to return
in all one large amount.

4) The company wanted to protect itself from being acquired by another company. In
the era of the Corporate Raider of the 1980s, many companies were concerned with
hostile takeovers. In many ways, the leveraged recapitalization made the company
a less attractive target as any prospective buyers would have to now take on Sealed
Air’s debt.

2. Value created for shareholders

Timestamp Closing Common Market Special Dividend Total Value

Stock Stock Value Value (Million $)
Price Outstanding (Million $) (Million $)
Before 45.875 8.245 378.2 0 378.2
Announcement
One Day After 50.5 8.245 416.4 0 416.4
Dividend
Announcement
One Day Before 50.75 8.245 418.4 0 418.4
Dividend
Payment
1 Day After 12.5 8.245 103.1 329.8 432.9
Dividend
Payment
End of 1989 20.375 8.245 168.0 329.8 497.8
(Dividend
Payment Year)

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)
6|Page GMP – Tata Steel (2019-20)

Thus, firm increased value created for shareholder by 31% in a span of 7 months after
announcing recapitalization. This value has come from appreciated share price of the
organization. This way the recapitalization helped the company recover from
undervaluation.

3. Analysing key financial ratios before & after recapitalisation

We have tried to analyse firm’s performance through key financial ratios. Since there
is not much data given in case for after scenario, we have tried to analyse the impact
of recapitalization by analysing the performance of 1989 (includes around 7 months of
post recapitalization period).

1989 1988 1987

Inventory Turnover Ratio 9.67 6.36 6.37
Debtors Turnover Ratio 6.55 5.95 6.27
Asset Turnover Ratio 1.67 1.34 1.33
Gross Margin 34.9% 33.4% 34.2%
Operating Margin 13.9% 12.6% 11.9%
EPS 0.87 3.07 2.49
P/E Ratio 22.90 14.67 14.88

▪ Inventory turnover ratio has improved in 1989 primary due to firm’s effort to reduce
inventories by WCM.

▪ Debtor turnover ratio has improved in 1989, primarily due to firm’s effort to keep
debtors’ minimum.

▪ Asset turnover ratio has improved drastically in 1989 due to increased sales and
reduced current assets.

▪ Operating margin has improved by a significant amount in 1989.

▪ P/E ratio of company has improved in 1989 by a great amount. Thus, one of reasons
behind recapitalization “undervaluation of firm” seems to be addressed by the
initiative.

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)
7|Page GMP – Tata Steel (2019-20)

4. Other impacts of recapitalization

▪ The capital expenditure reduced substantially from $20.5 million in 1988 to $13.4
million in 1989 and were restricted to only $7 million in 1990.

▪ By the end of 1989, Sealed Air’s strong cash flow allowed the company to repay
$30 million of bank debt and $5.1 million of its notes payable.

▪ Prior to the recapitalization Sealed Air's stocks were held by institutional investors
who were looking for a steady growth company with solid financials and limited
risk. After the recapitalization, many of the institutional investment funds had to, or
chose to, sell because of the rules or guidelines they had in place for their clients,
such as: market capitalization more than certain levels, requiring stocks to pay
dividends, leverage levels, deficit net worth. The new investors are more
speculative, looking for significant profits. This in turn has created a situation where
the managers may now be looking at the current month or quarter instead of the
long-term forecasts for the company's future.

Summary and Conclusion

Sealed Air Corporation (SEE) was of one of the firms that successfully used leveraged
recapitalization to increase value for shareholders. The stock of Sealed Air (SEE) –
which is a provider of systems and solutions for packaging and food science, building
care, hygiene, and food safety and security – was undervalued in 1989 as the company
was generating free cash flow (>$54Mn) more than what it could spend, thereby
creating a doubt in investors’ minds about the company’s ability to successfully deploy
that capital for growth purposes. SEE’s management then decided to purposefully use
leveraged recapitalization as a watershed event, creating a crisis that disrupted the status
quo and promoted internal change, which included establishing a new objective,
changing compensation systems, and reorganizing manufacturing and capital budgeting
processes. While the decision was initially met with substantial resistance (both internal
& external), it eventually resulted in the rise of the company’s stock price and valuation,
and SEE gradually lowered its debt to normal levels over the years.

Cheap Debt + Reasonable Priced Equities + Tax Savings =

Leveraged Recapitalisation

Team Members:
Anil Kumar Nayak (CGT19003) | Animesh Kumar Singh (CGT19004)
Ankit Bansal (CGT19005) | Bhavani Shankar (CGT19009)