Leveraged Recap

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Case2: Leveraged Recapitalization

Client: Sealed Air Corporation

I.Executive Summary
Founded in 1960, Sealed Air grew rapidly during its first twenty-five years because many products had strong patent protection. By the mid-1980s, the patent of air cellular had run out and competition was getting fiercer. The managers started to pay attention to manufacturing. Therefore, the Sealed Air launched World Class Manufacturing to promote manufacturing performance. After a year, this program had revitalized the company and enabled Sealed Air to have $54 million in cash. Because there was no profitable project available, Sealed Air managers decided to use Leveraged Recapitalizations to provide large payout to shareholders.

Leveraged Recapitalizations was a good idea for the Sealed Air Corporation’s shareholders and the company. The reasons are as follows: (1) Benefit the shareholders
A year after Sealed Air implemented the WCM, it had $54 million in cash and expected the cash to double in the next year and a half. The manager felt strongly that the company should not hold on to the cash because shareholders are not paying to invest their money in securities. So it was time to give the money back to the shareholders----a large payout to shareholders.

(2) Benefit the company
When the sealed Air Corporation undertook a leveraged recapitalization, the tax shield helped to decrease the tax of the company. A taxes shield is the reduction in income taxes that results from taking an allowable deduction from taxable income. Since a tax shield is a way to save cash flows, it increases the value of the business, and it is an important aspect of business valuation. Moreover, after the leveraged recapitalizations, the employees would have incentive to work more efficiently, because the company had more debt than before.

II. World Class Manufacturing (WCM)
(1) Introduction
The CEO believed that a change in the strategic direction of Sealed Air was necessary. The manufacturing was an essential component of the strategic change managers wanted to make. The World Class Manufacturing program provides solutions to manufacturing problems.

(2) The relationship between WCM and leveraged recapitalizations On the one hand, WCM is consistent with “levering up.”
“Levering up” means that the company keeps bringing on debt when it needs money. Since there is a huge debt, the company has to reduce the inventory and working capital. The idea of WCM is to achieve high quality, low cost, fast and dependable customer service and reduced working capital, which is consistent with “levering up.”

On the other hand, WCM is inconsistent with “levering up.” Because of “levering up”, there are constraints on Sealed Air’s capital expenditures It will be hard for the company to invest in new equipment, to do the lab research or to hire talented employees, all of which could help Sealed Air to achieve WCM’s goals.

III. Leveraged Recapitalizations
This fiscal transaction where a firm increases leverage substantially and makes a large cash payout to shareholders is called “leveraged recapitalizations.” In this case, Sealed Air used leveraged recapitalizations to finance a large payout to shareholders.

i. Financial Analysis
A value of $64.19 million was created. It came from tax shield of the interest of the borrowings for recap. To calculate the tax shield, we need to know the tax rate of Sealed Air Company and the every-year’s interest payment. According to Exhibit 5, in 1989, the EBIT was 53.7, the Interest outlay (net) was (17.1), and the income tax outlay was (12.9). (In million) So, tax rate R= Income tax/ (EBIT+ Interest outlays) =12.9/ (53.7-17.1) =35.25% The total borrowing associate with the leveraged recapitalization has two parts. (1) Loan from the banks

136.7million are under agreement with a weighted average interest rate of 11.5%. The principal repayments are as...
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