IIM RANCHI

Seagate Technology Buyout

Mergers, Acquisitions and Corporate Restructuring

Ankur Saurabh (M012/12) Tarun Gupta (M044/12) Rahul Gupta (M108/12)

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

4.4.1 4.4.2 4.5 5

Leveraged Buyout ......................................................................................................................... 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

6.1.1 6.1.2 6.2

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?

3 Theories to Solve problems

Below mentioned are some of the pointers that should be kept in mind while considering a Buyout transaction via Private Equity firm 1. Private equity can have a competitive edge over strategic acquirers because selling firms are more willing to let a private equity fund perform due diligence than a rival 2. Management buyouts are a flip side of private equity buyouts. Managers must rely on private equity to fund the acquisition, and private equity funds often rely on managements knowledge of the firm, its markets, and its customers for the success of the transaction 3. There can be large disconnect between the interests of private equity funds and those of the public investors. The limited partners may have no interest in holding the shares that have been 2

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 List of alternative Solutions to the Problem

4.1 Do Nothing
Doing nothing would leave Seagate hoping for the market to begin recognizing the value of its disk drive operations and base it on that, not the price of VERITAS stock Seagate owned. This would mean that shareholders would have to be willing to stick it out with Seagate, hope for the market to turn around and begin reflecting the value of the firm, and to recognize the value of the long-term investment with Seagate stock. This would be a risky route considering Seagates stock price was becoming increasingly tied to VERITAS stock price (Exhibit 4). With this decision, Seagate would have to look to outside financing in order to continue their ideas of expansion and consolidation. This would increase the debt of the company.

4.2 Unload All VERITAS Stake

Another option would be for Seagate to unload all of their VERITAS stock. However, the selling of VERITAS shares was limited by prior agreement with VERITAS. Even if they were able to sell a big chunk of their VERITAS stake, the transaction would be taxable at both the corporate and personal levels. Since this option is limited by the agreement with VERITAS, it is not a viable option. If it were not limited, it would still be a less likely choice due to the tax implications.

4.3 Sell to other Investors

If Seagate were to choose the option of selling to other investors, it would provide an opportunity for other companies that may be interested in purchasing Seagate to set and offer a bid price. However, it would be ideal for VERITAS to purchase Seagates shell (consisting of VERITAS shares, a few miscellaneous equity investments, and proceeds from the Seagate buyout) as Seagate owns 40 percent of their stake. Also, VERITAS is the only one who can issue their shares to shareholders without causing tax implications.

4.4 Vertical Integration

According to the case, in June 1999, Seagate had a credit rating of BBB. This was favourable for Seagate because this rating affected their ability to receive future financing. S&Ps listing of BBB is investment grade with medium risk. This is just one step up from their BB or B ratings listed as junk and high risk. The important thing for Seagate was to maintain their rating of BBB, or increase it. This integration caused the company to have high R&D and capital expenses, but as mentioned earlier, in a technological industry, the only way to get ahead or stay ahead is to increase expenditures in these two areas.

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

4.5 Leveraged Buyout

The buyout consisted of a two-staged transaction including a leveraged buyout of the disk drive operations and a tax-free stock swap with VERITAS. This option can help Seagate to address its low stock price and offload its VERITAS shares without undergoing significant tax liability

5 Analysis and Identification of the Right Alternative

We believe the proposed solution of a LBO by Silver Lake followed by the share swap agreement with VERITAS is the best possible solution for Seagate to increase its stock price.

5.1 Capital Structure for the LBO

Rating Debt as % of Market Cap % Debt % Equity AAA 3.7% 3.6% 96.4% AA 9.2% 8.4% 91.6% A 16.4% 14.1% 85.9% BBB 30.4% 23.3% 76.7% BB 47.5% 32.2% 67.8% B 59.3% 37.2% 62.8% CCC 74.3% 42.6% 57.4%

LBO Price Equity Debt

1180 944 236

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.

5.2 Payback Period

Year Total Cash flows Balance Complete Years Months Total Time Period for PayBack 2000 91.1 -852.9 2001 151.8 -701.1 2002 282.4 -418.8 2003 449.7 30.9

-944 3 11.2 3 Years and 11 Months

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.

6 Findings and Recommendation

6.1 Findings
6.1.1 LBO Price

Free Cash Flow to Firm(FCFF) NPV@15%

91.1 821.72

60.7

130.6

167.3

337.3

406.2

456.8

NPV for the Base Case

FCFF NPV@ 15% 91.06 1,538.27 176.9 376.74 387.78 580.22 661 749.22

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

7.72% 34% 704 8620 9324 7.6% 92.4% 15.32%

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