Sealed Air Case

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Sealed Air Corp.

Leveraged Recapitalization (1989)
Case Study

Abstract

The following report outlines the basics of a leveraged recapitalization, the benefits and consequences of a leveraged recapitalization, and ultimately Gator Consulting’s recommendations for when and how to use leveraged recapitalization. Much of this discussion is explained by citing a case study involving Sealed Air Corporation as a way to demonstrate a specific positive instance in the use of leveraged recapitalization.

Leveraged Recapitalization

Leveraged recapitalization is a financial strategy in which a company will take on large amounts of debt to either issue a large dividend or repurchase shares. The goal is to give as much back to a company’s shareholders as possible. This in part lowers the company’s overall Weighted Average Cost of Capital (WACC) since the cost of issuing debt is less expensive than issuing stock as debt holders are first in line during a liquidation of a company’s assets during bankruptcy. In other words, equity owners have more at stake than debt holder so more risk equals higher rates. Also, issuing debt provides a tax shelter as interest is tax deductible. This drastic approach to restructuring a company’s capital structure is still viewed as controversial as financial experts continue to weigh the pros and cons of going through a leveraged recapitalization.# Gator Consulting’s view is leveraged recapitalizations work only in very specific circumstances such as the Sealed Air Case.

Sealed Air Case Study

Sealed Air drew large, steady cash flows over the previous several decades under the protection of its patent portfolio of innovative packaging material. While the company continued to create large cash flow, the corporation was facing an aging patent portfolio that was quickly reaching expiration. Without product innovation, the company faced price cutting competitors, and would need to cut manufacturing costs to remain competitive.

In an effort to keep the company’s operations running efficiently, Sealed Air executed the World Class Manufacturing system. One of the main focuses in WCM is to keep inventory low. By keeping inventory low less money is tied up in working capital and cash flow is improved. To run a WCM program well, machinery must be kept simple and consistent so that maintenance and change over during manufacturing goes quickly and smoothly. WCM makes a business more flexible to changes in the manufacturing schedule.

While this system helped in making the corporation leaner, the large cash flows were continuing to give a false sense of security to management. Having too much cash on the balance sheet created several other challenges below, that a leveraged recapitalization would address.

Rationale for the leveraged recapitalization
The case of Sealed Air is relevant for other companies with similar capital structures and cash flows as those companies may have in common the challenges Sealed Air faced below.

First, the company looked at potential acquisitions as it was customary for the company in the past to use excess cash for M&A activity. At the time of the leveraged recapitalization, no other promising acquisitions existed. Furthermore, previous acquisitions failed to inspire or reinvigorate the product line or workforce. With the newly leveraged structure, the company would have to undergo much greater scrutiny prior to any new acquisitions versus before when the goal may have been to simply grow.

Second, the excess cash allowed management to remain complacent regarding innovative production techniques, as it gave the false sense of security and growth for the company. While the World Class Manufacturing initiative provided some manufacturers to become more efficient, the management ultimately feared having too much cash on the balance sheet would not continue to force manufacturers to constantly conceive of new and innovative ways to keep lean. Having a...
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