Motivation and structure of the deal. In early on 1999, Seagate was planning on major restructuring proposal with the private collateral firm, Silver precious metal Lake companions L. P. The plan implied a leveraged buyout of Seagate's disk drive operations, followed by the tax free acquisition of Seagate's remaining resources by VERITAS Software Firm. The choice for this two step transfer was mainly a result of Seagate's 40 percent ownership of VERITAS's common stock. In the last year the talk about price of VERITAS increased significantly and the marketplace value of Seagate's show in VERITAS had come to significantly exceed Seagate's entire market capitalization. The worthiness gap was due to the perceived taxes liability by the marketplace if Seagate were to market its VERITAS stake and Seagate's main disk drive operations were not fully valued in the market credited to increased involvement in Internet organizations and cheaper data storage space providers. The two-step transfer was thus believed by Seagate's management to create significant wealth gains because of its shareholders.
Before making their decision Seagate's must consider some alternatives to the recently described restructuring to be able to address its low stock price. The company could sell the business all together, repurchase its own stock or sell off area of the VERITAS stake, or undertake a tax-free spin-off of either the disk drive business or its stake in VERITAS. We talk about each of these alternatives next.
Seagate could choose to sell itself to other companies which may be interested. A merger or acquisition, in this case, could be either horizontal or vertical. Whereas a horizontal merger or acquisition could be beneficial for Seagate, due to even higher market in the competitive drive drive market, a vertical merger would be less successful as the business is already vertically integrated. However, it might be suitable for Seagate to be received by VERITAS as it keeps 40 percent of its shares. But VERITAS had not been interested in entering into the drive drive industry as management believed this is to a long way away from their center software business.
A second solution for the company is to market its VERITAS stock or repurchase its stock partially in the open market, however. However both activities became ineffective. First Seagate's potential to market of VERITAS shares was tied to a prior agreement made with VERITAS. Even if they could sell off the entire VERITAS stake, it still seems an undesirable outcome because the ventures would be taxable on both the corporate and business as personal accounts. Second when the company performed a repurchase it possessed little impact on its stock price.
A free of tax spin-off would imply Seagate spins off one of its business units, the core disk drive business or the VERITAS stake as an entirely new company. However the internal revenue code, as part of the US statuary tax legislations, requires that both distributing company and the manipulated organization must be engaged soon after the distribution within an positively conducted trade or business for a five-year period. Furthermore it also claims that the corporate divisions lacking a business purpose can't be accomplished tax free (IRS, 2003). Clearly the "VERITAS stake" corporation will not satisfy these conditions and thus a tax free spin-off is unlikely. Besides the syndication must be the final resort for solving the business problem. In other words, it must be proven that the business problem can't be solved otherwise. This problem also does not hold since, even as we will later see, the suggested two step transaction remains as a valid solution.
After critiquing these alternatives the proposed two step deal appears to be baneful, mostly because of its low tax character. As indicated in the case the stock-for-stock swap qualifies as a reorganization under the Internal Income Code, thus avoiding the duty implications as a swap. VERITAS will swap 109, 330, 300 stocks for 128, 059, 966 stocks previously owned by Seagate, and the duty gain will be Huge as no personal or commercial taxes need to be paid on the exchange. Furthermore the reduction in total outstanding stocks associated with the deal will cause earnings per talk about to rise, cetris paribus. Altogether this would be in the benefits associated with the VERITAS shareholders, allowing the two stage transaction to be pursued on their behalf.
Seagate's shareholders also take advantage of the potential restructuring program. First they will acquire 109, 330, 300 stocks that have experienced a cost increase of 200 percent following the half calendar year that used VERITAS acquisition of Seagate's Network and Storage area group. Compared to the 25 percent increase over the same amount of its own shares this is a significant difference. Furthermore they will receive an additional amount generated from the sales of Seagate's drive drive manufacturing possessions (including $765m of cash) to the "Suez Acquisition Company". The benefits to be received here, and thus also the benefits of Magic lake Companions L. P. are thus for the main part dependant on this price, that was not established yet. Seagate's employees will also benefit from the two step purchase as their motivation to perform rises significantly when the new "Suez Acquisition Company" is no more tight to VERITAS performance. Commercial governance is now appreciable tighter than in the old situation. A sincere loser of the reorganization is the government that can have gained more in taxes if one of the pre-described alternatives were chosen.
Levering the buyout
There are lots of benefits associated with leveraged buy outs. Business efficiency improvements, increased interest tax shields, change of management or improved upon management incentives and higher company value are the main possible effects.
In the case Seagate a rise of the stock price was the main target of the leveraged buyout. Prior to the leverage buyout Seagate's stock price was increasingly more tied to VERITAS stock price. The performance of Seagate's main business was a subordinated parameter. The trial to boost the stock price by means of selling VERITAS stocks and purchase own shares in the wild market didn't lead to the targeted aim for. Therefore a leveraged buyout was a possibility to lose the stock price from the performance of VERITAS. Besides of this main goal to disconnect the stock price development from VERITAS also other positive effects of leveraged buyout could be became aware, as the improvement of the marketplace position of Seagate from a strategic and long-term point of view. As a consequence a higher likelihood to secure a positive stock price development after being on the currency markets again can be gained.
Another positive facet of leveraged buyouts are fees that can be saved through higher obligations and interest that is tax-deductible. Though it is highly recommended that interest can't be deducted unlimited because of interest barrier rules or cash flow stripping rules. Therefore the interest only can be deducted to a certain extent, depending on debt-to-equity ratio. There are particular regulations that differ from country to country. In case there is cross-border leveraged buyouts the situation should be analyzed separately. Inside the EU there is absolutely no different treatment in cross-border situations because of the flexibility of establishment and the liberty of capital of the EC Treaty.
A decisive argument of leveraged buyouts is the possibility that enterprises which were poorly supervised before their acquisition can undergo valuable corporate reformation when they become private. A significant change in the organization structure is usually the modification and replacing of the management staff or improved management incentives. In the Seagate case Silver Lake was convinced about the abilities of the management team. Magic Lake argued that the members of the management team had over a decade of experience in the drive drive industry and underlined that it was an important condition of the offer that the six top professionals were bought out. In lots of articles it is argued diversely as a restructuring without changes of management personnel is much harder and there's a more robust opposition against many distressing but necessary changes. As bonuses the management had to convert some of these Seagate collateral into new equity and also got some deferred payment. The rejection of pointless company areas as well as the reduced amount of excessive expenditures is a significant factor for the success of the offer.
In the leveraged buyout market secure and predictable cash moves and significant tangible possessions that can be provided as security for loans are positive preconditions. These are features that produce an organization for private collateral firms interesting to get. Within the 1980s and early on 1990s industrial companies were strongly preferred and technology business was avoided. This has changed as the technology sector is becoming more and more important and in the last years this sector has become a lot more interesting for Private Equity purchases (von Nell-Breuning/2010).
The disk drive industry within the technology sector is distanced by heavy price competition, brief product life cycles which are often no longer than half a year and high expenditures on R&D. They are features that produce buyouts very dangerous. It creates it difficult to anticipate cash flows, which plays a substantial role for the success of a leveraged buyout. Nevertheless Silver precious metal Lake was convinced that on the whole the drive drive industry market development would be extremely positive and that the disk drives would be the main element technological element in hardware products.
It also should be studied into consideration that Seagate acquired lots of characteristics that were from a positive aspect for a leveraged buyout like vertical integration for a better competitive position on the market. But also high R&D while using up cash is a good aspect to avoid market accessibility of smaller, less well-capitalized rivals. Another advantage of Seagate was the relatively high equity ratio weighed against the technical industry. The equity ratio of Seagate was 26. 6 per cent in June 1997, it was 29. 6 per cent in June 1998 and in June 1999 the equity percentage constituted 23. 9 per cent. The equity proportion of its competitors were lower, f. former mate. the competitor Quantum HDD only got an equity ratio from about 13. 5 %. The average collateral ratio of older establishments is between 20 and 25 per cent depending on country.
In order to determine the capital structure of the offer and essentially the amount of credit debt the Luczo and the buyout team should take it is necessary to estimate the organization value. Two model are being considered because of this job. The first one is the relative valuation model. The rationale for comparative valuation is due to the notion that the intrinsic value of an asset is difficult to calculate. Its value can be assessed by the purchase price the marketplace is willing to cover its assets, established after its characteristics. The second model being considered is the DCF model. When comparing relative valuation with DCF, one benefits over DCF is the reflection of market perceptions on the value of the company. Thus, in a perfect market, the perceptions of future potential customers are already reflected in the stock price. It needs less information than DCF models and is also therefore less prone to estimation errors. In addition, managers are often judged on a member of family basis and comparative valuation might therefore match their needs and horizons. Marketplaces are assumed to make problems when pricing possessions across time. DCF valuations detach themselves from market valuations and evaluate the fundamentals underlying the firm and its own growth perspectives. Comparative valuation contributes to a reasonable estimation whenever there are many comparable investments that are priced in the market and a variable can be applied to standardize the prices. Although the case offers some information on competitors we deem the data to be inadequate. Even more, comparative valuation works best for investors that usually have relatively short investment horizons as it is extremely difficult or impossible for the marketplace to perceive long-term development perspectives. In general a private collateral investment(PE) spans on a 5 to 7 years' time series meaning the PE investor has a medium to long-term investment horizon. More confidence in reasonable company value estimation is thus designated to the DCF valuation. The fundamentals of any company provide a advisable basis for estimations. Assumptions for the estimations are clear while these are rather not in the case of relative valuation. A DCF valuation can be employed to long-time horizons and it is thus more applicable for investors with long-term investment perspectives. Furthermore, a fundamental way my work as a catalyst that goes the price in the market towards the real value of the belongings.
Silver Lake Associates L. P. , as the bidder for the controlling stake of the business is thinking about deriving the organization value, meaning the value of the collateral stake in association with debt. Cash flows coming from operating activities would therefore have to be estimated. An initial step concludes in the computation of free cash moves to firm (FCFF).
The company management provides three different projections for the buyout team: The Base Case, The Upside case and The Downside Case, each differing in EBITA and Profits values. Capital expenditures and Depreciation are to stay the same in every three cases. The ideals used are provided in the operating performance projections table of Seagate. The working capital(WC) is stated in the event to be historically add up to 0 for the industry therefore the change in WC is to be ignored. According to this values the FCFF can be computed.
After total cashflow is determined, it is cut back to NPV using the company's weighted average cost of capital (WACC). The WACC, which is defined by the relative cost of the business's debt and equity is also viewed as the 'required rate of come back' for the business and its investors to compensate them for the inherent dangers of ownership and realization risk for projected cash flows. The worthiness for the chance free rate and the marketplace risk prime have been place as distributed by Damodaran(2010) as 3. 20% and 2. 05% respectively. The beta of the company is supplied by the situation as 1. 2. Thus we come to the value of 6% for the WACC. Predicated on the prices of the FCFF and WACC computed we is now able to asses the present value of the company in the years to come. By summing up this worth for the mandatory time horizon we get to the firm beliefs for the three cases
Figure 1 Organization value analysis
As it can be noticed the firm values for the conditions register important differences. The Upside circumstance stands out. Comparable to this the Downside Case has a much smaller difference. To be able to better take into account the likelihood of worse than expected, but more importantly, for much better than expected performance in the business we consider that the common of the three values should be utilized as the company value and since the price the buyout team should pay so this means US$2. 224 billion.
We have determined a price of $2. 22 billion that Sterling silver Lake & Partners will pay to acquire the businesses of Seagate. This will be a leveraged buyout that includes two different equity sources and two different debt sources. Our proposed capital framework will contain 79% percent equity and 21% percent personal debt. This framework was chosen based on the BBB three-year median rates as referenced in the case (Show 11). The EBIT Interest Coverage ratio place the median value over 1997 to 1999 of 3. 9x. In order to get the highest value for the company when deciding to market it, the PE company will try to maintain its rating or to improve it so it is practical to consider the BBB value as appropriate. A lot more lower rating will also suggest higher interest rates for its debt. Applying this value and the EBIT values provided for the situation we can compute the amount of interest that the organization can afford to pay each year. It could be noticed in Display 1 that the cheapest value for EBIT is expected in season 2000 so that it is practical to consider this value as a standard as the next years the performance is expected to improve. Beginning with amount of interest that the firm can afford to pay each year we calculated the worthiness of arrears that the company has to ingest order to be asked to pay that amount of interest. This adds up to US$468. 31 meaning 21% of the purchase price recommended for the deal. By contrasting this effect with the ideals provided in Display 11 from the truth it can be pointed out that the firm will stay under BBB ranking. The rest of the 79% is usually to be provided by the buyout team in form of collateral. It should also be considered that Sterling silver Lake Associates L. P. will get US$765 million by acquiring Seagate, money that can be used as collateral for the offer.
Figure 2 level of debt analysis
In order to better assess the impact of the three cases on the capital structure of the offer we also used the values computed beneath the Base Case, The Upside Case and The Downside Case. Again it can be pointed out that the better performance predictions stand out. This is based on the possibility that in the second option years of the investment the company will perform over the expectations even though 2000 is perceived as the same in every cases.
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