Seagate Case free essay sample

Seagate Technology, Inc. is one of the world’s largest manufacturers of computer disk drives and related data storage devices with approximately $6. 5 billion in annual revenues. In early November 1999, Luczo, president and CEO of Seagate considered a restructuring proposal with Silver Lake, a successful private equity firm that is specified in technology business investing. 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, Seagates stock price increased by 25%, while VERITAS stock price increased by over 200%. This resulted in occurrences of Seagates stake in VERITAS exceeding the entire market value of Seagates equity, essentially assigning a negative value to Seagates large and market-leading disk drive business. Determine a buy-out price for the disk drive division of Seagate The discounted cash flow model provides a way to take into account a companys future growth predictions (Exhibit XX). Using the scenarios projected by Seagate management and Morgan Stanley, we calculated the future free cash flows for the company, and brought it back to NPV using the company’s weighted average cost of capital (WACC). The WACC calculated uses information provided in the case, and some market information. We came to 14. 84% company’s WACC (Exhibit XX). As sensitive case, we weight the three scenarios with different weight. Seagate performs better than average even with their low profit margin average. For this reason, we averaged the NPV of the down case at 20%, the base case at 50%, and the upside case at 30% to arrive at a LBO price. After discount cash flow model analysis on the three cases, we estimate the buyout price should be around $2. 77 billion. Determine the financing structure of the deal We have determined a buy-out price of $2. 77 billion that Silver Lake Partners will pay to acquire the disk drive business operations of Seagate. LBOs are often highly leveraged. The exhibit 7 in the case shows that from 1994 to 1998 the average LBOs used 20% of equity. However, this financing structure would not be possible for the new entity because the features of the disk drive business given the volatility profits. A more conservative capital structure would be necessary in order to maintain a grade rating BBB, and access future financing. Our proposed capital structure will consist of 70% equity and 30% debt as reflected in Exhibit 4. This would equate to $1. 94 billion in equity and $831 million in debt. This structure was chosen based on the BBB three-year median rates as referenced in the case Exhibit 11. Estimate the cost of financing, i. e. the credit rating and interest rate of Seagate Disk Drive after the buyout. After the buy-out the new capital structure of the business disk drive would be 70% equity and 30% debt. This capital structure will provide a credit rating BBB, and a cost of debt of 7. 72%. The new capital structure will present a new cost of equity for the business, since the debt-equity ratio will be different. The higher the percentage of debt in the financing structure, the lower the weighted average cost of capital. But the above average business risk and less predictable cash flow would limit the debt ratio only up to 30%, converting to 42. 86% for debt-equity ratio. Using this new debt-equity ratio, the cost of equity will be 17. 17%, higher than before the transaction (15. 48%). Compare your valuation to the proposed deal in the case. Regarding the drive business deal, Morgan Stanley proposed that $2. 05 billion was a fear value for the deal. The passages below are from the SEC’s document published. â€Å"The gross $2. 050 billion purchase price is subject to the condition that Seagate transfer to Suez Acquisition Company $765 million of cash in the leveraged buyout. This results in the cash portion of the purchase price available for payment to Seagates stockholders in connection with the merger to be approximately $1. 285 billion (less the amount of rolled equity)†. â€Å"While many of the implied equity values for Seagates operating businesses summarized in the table above exceeded the $2 billion purchase price in the leveraged buyout, Morgan Stanley arrived at its opinion that the consideration to be received by holders of Seagate common stock in connection with the merger was fair, from a financial point of view, to those holders, by considering all of its analyses of the merger and the leveraged buyout, taken as a whole. † The passages show that Morgan Stanley fear value was $2 billion for the business operation. This value is 43% lower than our valuation of $3. 48 billion for the deal. The passages and the published document are not clear why the fear value should be so low. This vague suggestion is more eccentric when we look the valuation made by Morgan Stanley. It had made a valuation using different methods such as comparable analysis, discount equity analysis, discount cash flow analysis, and sum-of-the-parts analysis, and different scenarios (Figure XXX). Based on the values that Morgan Stanley calculated, we calculated a weighted average value for it. Using the same weighted for each of the cases scenarios, and methods showed in the table, the average value for the deal was $3.47, which is the same value that we calculated in the present report. However, we did not get any substantial information that explains the difference between the proposed deal and the valuation value. The roles that valuation of Veritas Stock play in this acquisition 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, Seagates stock price increased by 25%, while VERITAS stock price increased by over 200%. This resulted in occurrences of Seagates stake in VERITAS exceeding the entire market value of Seagates equity, essentially assigning a negative value to Seagates large and market-leading disk drive business. The increasing value of the VERITAS stake meant that Seagate’s stock price was becoming increasingly tied to VERITAS ‘s stock price-and to the performance of Seagate’s core disk drive business. So the management team start to increase the stock price. The Valuation gap between Seagate stock price and its holdings of Veritas Stock In March 2000, Seagates stake in VERITAS was valued at $21. 6 billion, with an after-tax value of $14. 3 billion. Based upon Seagates financial data from June 1999 and projected future cash flows generated by their disk drive assets, the value of Seagates non-VERITAS component of equity is approximately $1. 8 billion. The undervaluation of Seagates component of equity was due primarily to two factors: Whether Seagate tried to sell VERITAS shares or distributed the shares to Seagate shareholders, a potential large tax liability would be created. Not only would Seagate itself be taxed ordinary 34% on the capital gains from selling the VERITAS shares, but shareholders would also be double taxed on their capital gains. As the core business of Seagate, disk drives had fallen victim to the market frenzy surrounding the emergence and growth of Internet businesses, and the gravitation of investors to favor this new industry over the more mature disk drive industry. The trend of the whole industry would limit Seagates ability to obtain long-term projects from public markets for future business expansion. Tax Liability Due to the large tax liabilities, the potential arbitrage opportunity represented with this undervaluation market inefficiency of Seagates disk drive operations is difficult to execute. Seagates management and shareholders felt they needed to reestablish the value associated with their core disk drive business, without incurring taxes, and that this value re-creation should happen through restructuring Seagate via leveraged buyout involving a private equity firm (Silver Lake Partners L. P. ). The proposed transaction must be structured to maximize value for Seagates shareholders. The team felt that this could be done by distributing the VERITAS shares tax free, sell the Seagates core disk drive business at a fair market value, and adsorb the remaining Seagate assets into VERITAS. It is important to note the necessity of distributing the VERITAS shares in a tax-free manner; simply selling the shares would result in a huge tax burden (34%) to the shareholders realized through capital gains due to the big increase in stock price. Conflict of interest between management of Seagate and private equity There is not usually a conflict between the management team of seller and the buyer in a buyout case. The management team can remain their control of the company while have cash reward and the buyer private equity could get an ideal return form purchasing a promising company. In this case, Silver Lake did have great confidence in the abilities of the Seagate’s current management team since the executives all had rich experience in the industry. But in this case, the percentage ownership by Seagate management team in this case. One reason is that they didn’t change all their stock to VERITAS and still have Seagate stock. The other is that outstanding equity is shrink because part of them had been replaced by debt. They are the actually buyer in this case and they should have a conflict of interest here. They are looking for the highest possible valuation, while the LBO firm is looking for a low valuation. In the end, a value needs to be assigned to Seagates disk drive assets and then split between the LBO firm and Seagates shareholders. Technology is not good for buyout Technology firms are generally not good candidates for leveraged buyouts by traditional standards because cash flows were extremely hard to predict due to rapid growth, short product cycles and substantial demand uncertainty. The lack of tangible asset in many technology businesses further reduced their attractiveness to LBO specialist. By the late 1990s technology buyouts began to emerge in certain segments of the technology sector that had begun to exhibit the maturity and stability typical of traditional LBO candidates, such as Seagates hard disk drive operations. Still, the leveraged buyout of Seagate does not fit the typical buyout criteria. Seagate is already completely vertically integrated, with RD and manufacturing under the same roof and there are not any apparent operating inefficiencies or underperforming assets, as Seagate is the market leading disk drive manufacturer. Also, the existing management team is expected to remain with Seagates disk drive operations. Thus, this transaction was a foray into new buyout territory, mainly the unlocking and rediscovery of firm value by wrenching it away from a non-core asset that had grown into a tax liability that was limiting the growth Seagate stock price. Conclusion After meticulously reading over the Seagate case, and the analyses relating to LBOs, we are certain that our figures are relevant and reliable. Morgan Stanley presented many important topics that are applicable to the deal, however, they did not go in depth into their final buy-out price suggestion and so we were left questioning their fair price for the business disk drive. We have considered all the alternatives and have come to a different price buy-out as Morgan Stanley had suggested and we feel that our calculations support the process we found crucial in a LBO. We believe that our methods fully support our LBO price of $2. 4 billion. The second step of the deal seems fair for Veritas and Seagates shareholders, because Seagate’s shareholders exchanged their shares paying a premium of 14. 84%, but they saved 13. 41% in taxes. The numbers are very similar, but this transaction was important so the overall deal came to happen. In addition, we have illustrated why the proper capital structure should be 30 percent debt and 70 percent equity. By implementing this capital structure Silver Lake will be able to accomplish their corporate goals.