1, Sealed Airs business:

a,
Sealed Air is one of the market leaders in protective packaging material and systems. The
operating processes are from manufacturing till delivery. Often, they sell products by contacting
directly with end users but then distribute the products via distributors or directly delivered to
buyers depend on which kinds of products.
Inventory: looking at the balance sheet statement and I calculated the common size balance
sheet, we may see that the inventory of the company accounts for about 14% of total assets in
1987 and 1988 but then decrease to just 11% in 1989. In about 1987, Sealed Air experienced
increasing competitive power from their rivals and they started to focus on manufacture. The
inefficient factories made them keep too much inventories leading to low inventory turnover and
high days cost of sales in inventory. However, after applying World Class Manufacturing
(WCM) this problem was solved which caused the substantial increase in inventory turnover and
decrease in days cost of sales in inventory in 1989.
1989
1988
1987
Inventory turnover
9.7
6.4
6.4
Days cost of sales in inventory
37.7
57.4
57.3
Capital budgeting: The priority in Sealed Airs capital budgeting changed over time. For their
first period of company life, they focused on the sales to exploit their strength in revolutionary
products. At this time, the managers had never concern about capital expenditures, no matters
what they needed, they were all satisfied. But from mid 1980s, the changes in market situations
made the company to turn their priority to manufacture including mainly in machinery and
maintenance. The investment in Property, plant and equipment was stable around 33% to 37%
during 1987-1989.
Cash
Short term investment
Receivables
Inventories
Prepaid expenses
Property, plant, equipment
Patents and rights
Deferred financing costs

Do, Ngoc Chau s133845

1989
25.5
58.8
25.9
2
112.2
85.1
7.4
12.9

11%
0%
26%
11%
1%
49%
37%
3%
6%

1988
28.1
27
58.1
36.2
1.7
151.1
83.7
7.6

11%
10%
23%
14%
1%
59%
33%
3%

1987
25.9
20.7
48.3
31.3
1.1
127.3
78.5
5.4

11%
9%
21%
14%
0%
56%
34%
2%

Page 1

Other assets

12.6
230.2

5%
100%

14.9
257.3

6%
100%

17
228.2

7%
100%

Cash management: After WCM, the companys goals based on EPS was replaced by EBITDA,
inventory turnover, receivables and working capital. The managers now have to consider much
more about cash flow and cash flow from operations become more important because they need
to increase sales, decrease inventory, capital expenditures and boost the collections process.
b,
Strategic change in management is necessary because Sealed Air former organization and
operation revealed lots of problems: running out air cellular patent, competitive tension,
underperformed factories, long inventory turnover, inadequate quality controlRegardless of
their inefficient manufacture, they still have high margins because they priced their products
based on customers benefit instead of cost driving. And because their patents are innovative and
widely used while there were not many rivals in the market, the benefit to customers seemed
constantly high.
c, Internal changes:
- Changes at Packaging Products Division: increase in the productivity from 1 item/day to 8
items/day, no more unsold products. They use short production runs so that the process control is
better but also it requires more expenditure in machinery maintenance to keep tracks with orders.
- Changes at Food Packaging Division: Operators and employees are inspired and motivated
with training, discussing and suggestion rewards leading optimistic changes in quality,
productivity and employees excitement.
2, Free cash flow:
a, Free cash flow (FCF) is cash flow generated by the firm in excess of that required to fund
available positive net present value projects or the amount of cash that a company has left over
after it has paid all of its expenses, including net capital expenditures. Net capital expenditures
are what a company needs to spend annually to acquire or upgrade physical assets such as
property and machinery to keep operating.
Free cash flow = cash flow from operating activities - net capital expenditures (total capital
expenditure - after-tax proceeds from sale of assets)
b, the organization problems of FCF are the conflicts of interest between shareholders and
managers especially when ample of FCF are generated. The shareholders goals are profit so they
may want to use FCF to invest in risky projects while managers may invest it in low return
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Page 2

projects or waste in on organization inefficiencies. Managers would like to keep earning retains
rather than paying dividends as it allows managers to maximize their control over such assets.
c, A company can use cash to:
- repay debt-holders,
- pay/increase common and preferred dividends,
- repurchase equity,
- ask for debt,
- launch a capital expenditure project
- acquire another company or invest in a portfolio of securities
In the case of Sealed Air Corporation: D/E of the company was low (around 7%-9%) so they did
not have to be worried about paying debt. Therefore the company can ask for more debt, invest
in new projects or pay out dividends or repurchase equity. Because the managers did not find any
potential profitable projects, this choice was eliminated. Thus, Seal Air should use its cash to pay
dividends, repurchase equity or to borrow more loans or combine the above suggestions. A
financial leverage could help improve the internal control and performance.
3, Leveraged recapitalization:
a,
Sealed Air borrowed more than $300 million ($136.7 million as senior secured bank loan and
$170 million as long term subordinated bridge notes) to pay a $328 million in dividends for
shareholders (equal to $40/share). Before this special events, Sealed Air held 8.245million shares
priced was between $44 to $46/share. After paying large amount of dividends, the D/E of the
company raised from 13% to nearly 136% and negative net worth of $160.5 million.
The transaction financing was as follows:
10 year senior subordinated notes (12.625%/y):

$170 million

Senior secured bank credit:

$136.7 million

Dividend received from subsidiaries:

$5.6 million

Liquidated short term investments & cash:

$15.7 million

Total:

$328 million

Balance sheet diagram

Cash
Short term investment
Do, Ngoc Chau s133845

1988
28.1
27

1989
25.5
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Deferred financing costs

0
Other assets
202.3
Total assets
257.4
Liabilities
33.5
Equity
162.3
Others
61.6
Total liabilities and equity
257.4
Sealed Air ended up with negative net worth

12.9
191.8
230.2
311.l
-160.5
79.6
230.2
because this is a leveraged recap transaction, and

then the value of equity after the recap is calculated as follows:

Value of firm Value of post recap debt = $20.4/share x 8.245.000 shares $328 million 160.5 million.
b, Value created for shareholder
Closing stock
Market value ($ Special dividend value Total value ($
Date
price ($)
million)
($ million)
million)
Before
announcement
45.875
378
378
1 day after
announcement
50.5
416
416
1 day before
dividend paid
50.75
418
418
1 day after
dividend paid
12.5
103
329.8
433
ending of 1989
20.375
168
329.8
498
The value came from the increase stock price because the shareholders expect to benefits from
this special dividend event. Benefits from tax exempt for debt also increased the EBITDA, and
profits of the company leading to relatively high price of stock at the end of the year.
Its hard to define if investors anticipate substantial value creation through improved internal
control and increased efficiency, but according to the increase in the stock price after the
announcement and before the dividend payout date it can be said that they have optimistic view
about the strategy of the company.
c, Sealed Air undertook a leveraged recap because:
- Excess FCF after WCM made the stock price of the company undervalued and they had to find
solutions to improve this.
- The FCF was expected to double over the next year after 1989 and it seemed that cash would
be wasted unless the company has a shakeup.
- Leveraged recap was used as a tool to tool to improve the internal control systems,
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which together with the high debt service created an environment that led to enormous
performance improvements and value creation.
- On top of that, borrowing and paying the proceeds to shareholders served to reinforce
managements promise not to retain future excess cash.
A leveraged recapitalization in case of Sealed Air in my point of view was a good idea because
the corp. was in a stage where they had adequate manufacturing capacity to meet the demand for
its products during the next several years without significant additional capital expenditure.
Moreover substantial excessive cash flow generated from the operations was more than enough
to support the growth of their operations and capital expenditure. The recapitalisation is good for
both the organization as well as the investors. By using the leveraged recapitalization the
management created a crisis that disrupted the status quo and promoted internal change, which
included establishing a new objective, changing internal systems, and reorganizing
manufacturing and capital budgeting processes. It is also good for investors because they can
used the dividends paid to invest in other assets which help diversify their own portfolios,
generate returns that Sealed Air stocks could not while they still keep their role of owners of the
company. Meanwhile, the current situation of Sealed Air allowed them to expect in the growth in
increase of the stock price in the future.
Difference between recap and LBO:
- Recap uses debt to pay special dividends or repurchase equity while LBO uses debt to acquired
a company.
- Leveraged recapitalization transactions do not require public companies to go private
again, thereby, helping them avoid legal and other associated challenges that accompany an
LBO transaction. For public companies, this also means easier access to capital markets and
funds, whereas private companies continue to

be

exempt

from

the

SECs

reporting

requirements for public companies, which consumes time and monetary resources.
- Recaps have lower potential for costly disagreements among stockholders since shareholders
are allowed to sell their holdings, if they disagree with corporate policies. On the other hand,
the reduced marketability of nonpublic sharesallows LBO investors to impose costs on
managers by forcing them to hold poorly diversified and/or illiquid portfolios.
4, The effect of the recap on firm value and performance:
a, Improvement of the companys operation performance:
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- More sufficient cash management: 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.
- Gross profits increased 17% while EBITDA increased 24% compared to 1988.
- By the end of 1989, Sealed Airs strong cash flow allowed the company to repay $30 million of
bank debt and $5.1 million of its notes payable.
b, WCM is inconsistent with levering up?
WCM adaptation helps improve the firms performance by reducing any unnecessary cost in the
storage of inventory, inefficiency in the production process, any duplication of work and also the
elimination of non-valued added activities. This leads to an increase in productivity,
improvement in cash flow generation and management. However, without recapitalization, the
cash flow generated as benefits from WCM may not be used efficiently. So taking a recapitalization would have allowed the organization to become stricter about maintaining its cash
flows and avoiding any inefficiency in its operations. It also focuses the attention on taking
discipline approach towards capital evaluation program due to which the WCM approach would
not continue to yield more benefits in the long term without the implementation of the recapitalization program.
c, In my viewpoint the constraint imposed on capex under the bank lending agreement good for
the company because as the lender, the bank has to do carefully research on their borrowers
situation and then set an appropriate capex schedule which guarantees the ability to pay out debt
of the borrowers. Moreover, the restriction in Capex make the firms managers to concentrate
more on their cash flows and capital budgeting decision and be stricter with any expenses. This
covernant, I think may be renegotiated provided that the company can prove their ability to grow
in the future and repay debt.
d, Increase in leverage is not good for all companies because it depends on the organizations
ability to generate cash and continuing making profit in the future otherwise it would face the
liquidation problems when the due time comes. Different companies have different optimal debt
levels based on different industry, different market, and different developing stages. For
example, technology companies tend to have very low debt because increasing debt may lead to
pessimistic react from customers.
Dangers of an over-leveraged firm:

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- Taking too much debt may lead to financial distress cost in the form of loss in sales due to
competitive price war and customers reaction towards the over leverage.
- effect on the available cashflow for other investment projects.
- firms operations are restricted by constraints of debt covenant.
Sealed Air is not in dangers attached to over-leveraged firm because:
- By adopting WCM before recap allows the company to well generate cash flow, better control
their internal operating expenses.
- The products and patents of the company are favored by customers and the companys policy to
encourage employees innovation keep the productivity, the quality and the therefore, the
profitability on track.
5, Changes in organizational priorities and compensation:
a, new incentive program
- Focusing on customers, which is the critical variable in ensuring the long term success of the
organization as they are the main stakeholders with heavy influence over the organizations
ability to generate profitability.
- The cash flow maintenance serves as a key variable in ensuring the organizations survival and
success as it is a real measure to increase its shareholder value.
- WCM helps the organization to maintain quality in its operations through total quality
management and just in time.
- Innovation is made through identifying new ways of producing product or selling it. It also
includes the technological development in the organizations product.
- Increase in earnings per share is a key ratio, which is often viewed by shareholders for making
investment decisions.
- A new bonus plan that focuses on the effective management of cash flows are critical in
ensuring the long-term success of the organization, so this approach would avoid taking any
reliability on non-cash flow measures such as accounting profit that merely create value in
papers, not in reality.
- Share ownership plans which allow giving some stake of the organization to its employees in
order to align their objective with that of shareholders. Moreover; the incentive plan also
includes the sharing of profit which would further motivate employees to take initiatives.
b,
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Because of the sudden increase in in debt and the requirements from the bank and debtholders,
the company needs to change their priorities and incentive structure after recap to assure the cash
flow generation without affecting on the shareholders value creation. the new bonus plan and
new employee stock ownership was introduced so as to serve as an act of extrinsic motivation for
the employees to work towards their objectives.
c,
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 in excess of 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 employees stock ownership contributes to this change in investor base.
d, The leveraged recapitalization can be considered as a takeover defense because:
- by increasing debt dramatically, companies hope to make the takeovers worried about
repayment debt after acquiring the companies.
- leveraged recapitalization distribute a large amount of cash to shareholders in form of paying
dividends, repurchase stocks or exchange offer. Thus restricting the new outsider ownership.

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