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1. Describe the main terms of the Seagate Technology buyout? Why is Seagate undertaking this transaction? Is it necessary to divest the Veritas shares in a separate transaction? What are other alternative ways to create value?
The primary contemplated terms would be to sell Seagate’s disk drive mfg assets including $765M in cash to Suez Acquisition Company controlled by Silver Lake Partners. The purchase would be financed by equity put up by Silver Lake and also by an, as yet, undetermined amount of debt. In a second stage, the remaining assets of Seagate (essentially Veritas stock) would be merged with Veritas in a tax free stock swap.
Seagate is undertaking this transaction because it was it wants to decouple the share from Veritas and also to fully realize the value of the disk business from the Veritas shares. The proposed transaction was designed to allow Seagate shareholders to realize the full value for the company, by distributing Veritas tax free and by selling the disk drive operations at fair market value.
An alternative would be, in order to avoid taxes, Veritas would buy Seagate and spin off the Seagate disk business to Veritas shareholders.
2. What are the benefits of leveraged buyouts? Is the rigid disk drive industry conducive to a leveraged buyout?
A positive aspect of LBOs is that poorly managed firms can undergo valuable corporate reformation when they go private. By changing their corporate structure, replacing executive staff, unnecessary business units, and controlling costs, a company can revitalize itself and earn substantial returns. Since this type of acquisition involves a high debt-to-equity ratio, one corporation can easily acquire another company with little capital. If the acquired company’s returns are greater than the cost of the debt financing, then all stockholders can benefit, further increasing the value of a firm. Also, as a result of the high leverage and tax deductibility of leverage interest payments, the company’s bottom line is improved.
Because the cash flows are unpredictable, the disk drive business is not an ideal target for an LBO. In the event that cash flow from the disk drive business misses its target in a period, the new entity would run the risk of missing debt payments and risking bankruptcy.
3. How much are Seagate’s operating assets worth? How much debt would you recommend to be used in the transaction? What is your assessment of the pro-forma financial projections? Do they seem reasonable? Be sure to explain the valuation method you are using and how you computed the appropriate cost of capital.
Seagate has $7.072B in operating assets.
Seagate should take on no more than 80% debt, but preferably less due to the volatility of its income.
The pro forma projections seem reasonable because we expect the PC, mobile and other device (Tivo, Xbox) market to increase in the future which will increase the demand for storage devices.
We used APV to determine the appropriate cost of capital. Ro=11.62%. Rd=7.72%. One assumption made was that the riskless cost of capital was 5%. The debt to market value ratio is 80%. The WACC is 11.93%.
4. Assume that the buyout team will exit the investment in 5 years. What is the IRR of the investment under different assumptions for the exit multiple?
The IRR for the base case is -2%. The IRR for the upside case is +10%. The IRR for the downside case is -8.0%.