Case Study Analysis
1. Why is Seagate undertaking this transaction? Is it necessary to divest the VERITAS shares in a separate transaction? Do the shareholders of VERITAS gain or lose from this transaction?
Under the original organizational structure, Seagate’s management believed its current stock price is undervalued by the current market and thus not delivering the value to shareholders of Seagate stock. At this time, Seagate also held a significant stake in VERITAS stock, nearly 40%, acquired under a previous transaction. Not long after this initial transaction had occurred, the value of VERITAS stock increase nearly 200%, as Seagate’s stock rose only 25% during that same period. The value of the Seagate’s interest in VERITAS shares became so significant that the value of this single asset exceed the entire market value of Seagate’s operations. This raised a question in the minds of shareholders, questioning why Seagate’s stock was not returning a fair value in the market. If Seagate were to sell this stock and collect cash in return, they would be subject to significant tax liability, and thus would negatively affect Seagate’s stock price. Also, under the terms written in the previous transaction, Seagate was under strict limitations regarding selling the VERITAS stock. Realizing that their disk drive operations, despite being a market leader, were extremely undervalued, Seagate would have the chance to capitalize on the true market value of their operations for their shareholders by restructuring through a buyout.
The structure of the buyout of Seagate by Silver Lake is necessary. One of the major dilemmas in structuring the buyout is the large tax liability Seagate would incur when selling the VERITAS stock asset. Therefore, it is critical that two separate transactions are used to help create tax shield, protecting the value of Seagate’s and VERITAS stock, maximizing the return to the Seagate and VERITAS shareholders from the LBO transaction. Also, through this structure, the VERITAS stock holders are also going to incur a gain from the transactions.
2. What are the benefits of leveraged buyouts? Is the rigid disk drive industry conducive to a leveraged buyout?
There are several benefits of leveraged buyouts:
1) LBO’s can increase management commitment and effort because they have greater equity stake in the company. 2) Firm’s shareholders can earn large positive abnormal returns from leveraged buyouts. 3) Post-buyout investors in these transactions often earn large excess returns over the period from the buyout completion date to the date of an initial public offering or resale. 4) The increased levels of debt that the new company supports after the LBO decreases taxable income, leading to lower tax payments. Therefore, the interest tax shield resulting from the higher levels of debt should enhance the value of firm.
The rigid disk drive industry is very conductive to a vertically integrated LBO as having control over critical enabling technologies by developing them in house meant that the desktop, enterprise and mobile system manufacturers would not have to depend on independent suppliers to develop these technologies. The manufacturers can also control R&D by offering cutting edge technologies in its products. The desktop, enterprise and mobile system manufacturers would have more control over the manufacturing process and can also maintain lower inventories of disk drive components, since it did not have to worry whether the disk drive suppliers would be able to provide it with components during a sudden increase in demand. 3. Luczo and the buyout team plan to enhance their acquisition of Seagate's operating assets using a combination of debt and equity. How much debt would you recommend that they use? Why?
Based off of our valuation of the transaction, we recommend that Luczo and the Buyout firm begin with a debt to equity ratio or .86 in year...
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