Seagate Buyout March, 2000
Seagate • Largest of six major suppliers of disk drives Table A 1999
Market Share in the Worldwide Disk Drive Industry,
Total Marketa Number of units shipped Seagate Quantum IBM Maxtor Fujitsu Western Digital Samsung Total sales ($millions)
Enterprise
Desktop
21.1% 17.1 14.0 13.3 12.3 11.1 5.9
41.0% 7.2 3 4. 6 b 8.8 3.8 b
21.1% 20.5 6.1 17.7 12.4 14.6 7.5
$25,273
$7,438
$14,627
Source: “Disk Drive Quarterly Report” (March 2000) by Salomon Smith Barney. aInclude Includes s mobile. mobile. b Amount is not material.
Seagate • Largest of six major suppliers of disk drives Table A 1999
Market Share in the Worldwide Disk Drive Industry,
Total Marketa Number of units shipped Seagate Quantum IBM Maxtor Fujitsu Western Digital Samsung Total sales ($millions)
Enterprise
Desktop
21.1% 17.1 14.0 13.3 12.3 11.1 5.9
41.0% 7.2 3 4. 6 b 8.8 3.8 b
21.1% 20.5 6.1 17.7 12.4 14.6 7.5
$25,273
$7,438
$14,627
Source: “Disk Drive Quarterly Report” (March 2000) by Salomon Smith Barney. aInclude Includes s mobile. mobile. b Amount is not material.
Disk Drive Market: 90’s • 1992-1999 average unit sales growth of 22.6% • 1992-1999 average revenue growth of 1% Exhibit 1
Worldwide Hard Disk Disk Drive Drive Industry Historical Performance and Projections, Projections, 1991-2003E
1991 Total Sales (000s of units) Y/Y % Change
33.1
1992
1993
1994
1995
1996
1997
1998
1999
38.4 16.0%
51.8 34.9%
69.0 33.2%
90.0 30.4%
106.8 18.7%
129.3 21.0%
143.6 11.1%
165.9 15.5%
2000E
187.8 13.2%
2001E
212.5 13.1%
2002E
238.1 12.1%
90's 2003E average
268.2 12.6%
22.6%
Total Revenues (millions $24,300 $26,200 $21,730 $22,966 $22,991 $27,596 $27,340 $25,483 $25,273 $26,640 $28,409 $30,450 $32,699 of $) Y/Y % Change 7.8% -17.1% 5.7% 0.1% 20.0% -0.9% -6.8% -0.8% 5.4% 6.6% 7.2% 7.4%
1.0%
Seagate: ‘90’s • ’92-’99 Average revenue growth of 15.9% – ‘92-’99 average industry revenue growth of 1%
• ’90’ ’90’s s Ave Avera rage ge EBIT EBIT marg margin in of 6.7% 6.7% – ‘92-’99 average industry median EBIT margin of 2.6% Seagate Sales ($ million) % Growth EBIT ($Million) % Sales Disk Drive Industry Medians
1990 2413
179 7.40%
1991 2677 10.9%
1992 2875 7.4%
1993 3044 5.9%
1994 3500 15.0%
1995 4540 29.7%
1996 8588 89.2%
117 4.40%
140 4.90%
284 9.30%
311 8.90%
443 9.80%
627 7.30%
1997 8940 4.1%
1998 6819 -23.7%
1999 6802 -0.2%
1020 -138 11.40% -2.00%
398 5.90%
Average 15.9%
6.7%
Seagate • Higher than industry average sales growth and EBIT margins – Regarded as an efficient low-cost producer
• Volatile Revenues – 6-12 month product cycle • Requires frequent access to capital to finance new products
– Reduced industry demand for disk drives during the early 1990’s and 1997-8 • Seagate fared better than other firms because of diversified product mix
Seagate • Vertically integrated (case p. 4) – Unique in industry – Designed and manufactured components as well as assembling • Gave Seagate the ability to more quickly respond to changes in demand and general economic conditions • Requires high R&D expenditures
Seagate • Restructured in late ‘90s – New CEO in 1998 – Expected increases in Cap Ex and R&D • Requires easy access to capital markets to raise funds – Could be made more difficult with high leverage resulting from an LBO
Seagate and Industry Capital Structure From Exhibit 2 1990
1991
1992
1993
1994
1995
1996
1997
1998
1999 Average
Seagate Debt/Book Assets Debt/Mkt. Assets (Debt-Cash)/Book Assets (Debt-Cash)/Market Assets EBITDA Interest Coverage EBIT Interest Coverage
31% 28% 17% 15% 6.10 3.68
23% 27% 9% 11% 6.01 2.76
18% 16% -10% -9% 9.09 4.11
14% 14% -17% -17% 18.67 12.08
19% 18% -27% -26% 17.05 11.81
16% 12% -21% -15% 19.11 13.44
15% 11% -7% -5% 17.99 11.24
10% 6% -24% -13% 43.66 29.27
12% 8% -20% -13% 8.84 -2.71
10% 8% -13% -10% 20.25 8.29
16.8% 14.8% -11.3% -8.2% 17 9
10% 9% -7% -4% 6.03 3.30
13% 8% 2% -1% 4.06 1.55
16% 16% -1% -3% 9.00 4.31
19% 13% -9% -3% 4.38 -0.05
12% 7% -4% -2% 5.58 0.37
10% 3% -8% -3% 3.59 1.84
13% 4% -6% -5% 7.06 5.04
6% 1% -21% -8% 13.00 8.52
14% 7% -9% -5% 4.20 -2.04
9% 4% -23% -5% -0.09 -2.91
12.2% 7.2% -8.6% -3.9% 6 2
Disk Drive Industry Medians Debt/Book Assets Debt/Mkt. Assets (Debt-Cash)/Book Assets (Debt-Cash)/Mkt Assets EBITDA Interest Coverage EBIT Interest Coverage
Seagate Credit Rating: BBB
Prelude to the LBO • May,1999: Seagate sells it’s Network and Storage Management group to Veritas Software – Receives 155 million shares of Veritas stock • 40% of Veritas outstanding shares • Seagate becomes the largest Veritas stockholder
Prelude to the LBO • November, 1999 – Veritas’ share price had risen by 200% since Seagate had acquired its stake – Seagate’s share price had increased by 25% – Seagate’s market cap was below the market value of the 128 million Veritas shares Seagate still owned (see Exhibit 4) • Implies negative value for Seagate’s operations • Seagate by this time had sold some Veritas shares in an attempt to realize some of the value of its stake
Seagate’s Value • Exhibit 4 shows that by November 12, 1999, Seagate’s market cap had fallen below the pre-tax value of it’s stake in Veritas • Soon after that Seagate’s market cap appears to track the after tax value of its Veritas stake
Market value of Seagate’s Operations (3/10/00) ($million) Seagate shares (million) (3/10/00) EX3 share price (3/10/00) EX3 Seagate Market cap $mill Seagate Book Debt (3/10/00) EX3 $mill Seagate's excess cash* $mill Net debt $mill Seagate's Asset Value $mill
227.2 $64.25 14598 704 858 -154 14444
Seagate's Veritas Shares(million) (3/10/00) EX6 Veritas share price (3/10/00) EX5 Value of Seagate's Veritas shares $mill Implied Value of Seagate's opers $mill**
128 $168.69 21,592 -7149
* 1999 cash = $1,623 million Treat $765 million as WC cash **If we assume Seagate’s Operations have no value, $7,149 is the undervaluation
Raising Seagate’s Market Value Selling the Veritas Shares • Seagate had tried selling some of its stake in Veritas – Sale of a large stake has a market impact • Seagate’s ability to sell was, in fact, restricted by a prior agreement with Veritas
– Proceeds of the sale create a corporate tax liability: • The 200% increase in the Veritas share price implies that 67% of value raised by selling shares is taxable at the 34% corporate rate
The Tax Liability Created by Selling the Shares • Selling Seagate’s Veritas shares creates a tax liability – Since the value of Seagate’s stake in Veritas has appreciated by 200%, two-thirds of this value is taxable $million Value of Seagate stake in Veritas (3/10/00 Capital gain Corporate tax liability @34% after tax value of share sale
21592 14467 4919 16674
Does the Tax Liability Explain the Undervaluation? • Note that the tax liability of $4.9 billion accounts for almost 70% of the undervaluation of $7.1 billion, assuming the value of Seagate’s operations is zero
Raising Seagate’s Market Value • One solution to Seagate’s undervalution is to sell the Veritas Shares – The drawback is the tax liability that creates – Anothrer drawback is the market impact of such a large sale – Also such a sale is restricted by agreement with Veritas
Raising Seagate’s Market Value • The buyout deal was proposed as an alternative solution – Structure of the deal is described below
• We’ll use the share sale as a benchmark – We’ll compare how the Seagate shareholders do with the buyout to how they would do if the shares were simply sold and the taxes paid
Selling the Shares • If Seagate’s Veritas shares were sold, Seagate would receive $16.674 billion after tax – Ignores the market impact of the share sale
• Proceeds of the share sale and the excess cash can be used to pay off Seagate’s debt and pay a dividend of $16.674 + .858 - .704 billion = $16.828 billion • Seagate’s market cap would then equal the value of it’s operations
The Gain • The gain from the sale of Veritas shares is $16.828 billion less Seagate’s market value of $14.598 billion – So the gain is $ 2.230 billion – Share price should then also equal the value of Seagate’s operations
Solving Seagate’s Problem • Alternative solution: two stage transaction – First: Sale of Seagate operating assets plus $765 million in cash to newly formed “Suez Acquisition Company” controlled by Silver Lake Partners – Second: Merger of Seagate “shell” with Veritas • After first stage sale of Seagate operations Seagate’s assets are its Veritas shares
Terms of the Merger • Because it’s a stock swap and reorganization, no tax liability is created • Seagate shareholders receive 109 million shares of Veritas plus cash for 128 million Veritas shares – Cash includes $858 million = ’99 cash less $765 million – Cash also includes proceeds from sale of Seagate’s operating assets less existing debt retired
Perspectives on the Deal • Seagate Shareholders – What do they gain from the deal? – Is this better than selling the shares
• (Non-Seagate) Veritas Shareholders – What do they gain?
• Silver Lake partners – How much should they pay for Seagate’s assets? – How should they finance the buyout?
Valuing Seagate’s Assets • What price should Suez pay for Seagate’s operating assets? – How do we value these assets
• How should the buyout be financed – Is Seagate a good candidate for an LBO?
• How does the financing affect the value of the operating assets?
Using APV • Arriving at UFCF – Use exhibit 8 projections
• What terminal value? – Use perpetuity (or multiple?)
• Unlevered return? • How much debt – Use two different assumptions
Cash Flows Exhibit 8 Revenues EBITA after tax oper profit (t=34%) depreciation Cap Ex net working cap incr (22% of rev inc) UFCF TV (perp: ru = 10.53%, g = 3%) UFCF + TV PV @ 10.53% PV of tax shield = .34x500 operations value debt debt/value
2000 6619 141 93 625 627
2001 7417 189 125 626 690
2002 8564 316 209 642 720
2003 9504 449 296 666 795
2004 10416 499 329 708 700
2005 11359 614 405 726 725
2006 12350 724 478 729 750
-40 131
176 -115
252 -122
207 -39
201 137
207 199
131
-115
-122
-39
137
199
218 239 3266 3505
1,839 170 2,009 500 0.25
Debt = $500 million indefinitely
Working capital 97
98
99
revenues cash cash work cap % rev receivables % revenues inventories % revenues current assets % revenues
8940 1033 12% 1041 12% 808 9%
6819 788 12% 799 12% 508 7%
6802 786 12% 872 13% 451 7%
32%
31%
31%
accounts payable % revenues
863 10%
577 8%
714 10%
net working capital % revenues
2019 23%
1518 22%
1395 21%
2717 30.39%
2241 32.86%
1773 26.07%
net working capital in Ex 3
avg
22%
Cash Working Capital • It was assumed that the $765 million in cash that Suez would receive was cash for working capital – This was 12% of the projected 2000 Revenues of $6.619 billion – So we used 12% as the fraction of revenues required for working capital cash – If we assume WC cash is 12% of revenues, and use Exhibit 3 to get other current assets and liabilities, net WC is on average 22% of
The Unlevered Return • We can’t use Seagate’s beta to obtain an unlevered beta – This is due to Seagate’s large stake in Veritas • As noted, Seagate share price tracked that of Veritas
– For the purpose of valuing Seagate’s operations we use the beta’s of the company’s that focus on producing disk drives • Quantum, Western Digital and Maxtor
Unlevering Quantum’s Beta Mar-00 EMRP 30 yr Gov't
6% 5.84%
Quantum debt (book) equity (book) equity (mkt) D/E (book) D/V (book) D/E (market) D/V (market) Debt return (BB rating) beta equity beta debt unlevered beta
110 791 733 0.14 0.12 0.15 0.13 9.18% 0.8 0.56 0.78
Unlevering Western Digital’s Beta Mar-00 EMRP 30 yr Gov't Western Digital debt (book) equity (book) equity (mkt) D/E (book) D/V (book) D/E (market) D/V (market) Debt return (BB rating) beta equity beta debt unlevered beta
6% 5.84%
236 -154 670
0.35 0.26 9.18% 0.6 0.56 0.59
Unlevering Maxtor’s Beta Mar-00 EMRP 30 yr Gov't
6% 5.84%
Maxtor debt (book) equity (book) equity (mkt) D/E (book) D/V (book) D/E (market) D/V (market) Debt return (BB rating) beta equity beta debt unlevered beta
114 169 1316 0.67 0.40 0.09 0.08 9.18% 1 0.56 0.98
average unlevered beta
0.78
Avg of Maxtor and Quantum
0.88
Unlevered Returns EMRP 30 yr Gov't unlevered beta unlevered return
6% 5.84% 0.59 0.78 0.88 0.98 9.39% 10.53% 11.10% 11.70%
Alternative Assumptions about Debt • First, suppose that $500 million of the acquisition is debt financed and that debt is maintained at that level indefinitely – Use perpetuity to calculate PV of tax shield
• Second, suppose that the initial debt is $1 billion and that debt is paid down when cash flow is positive until debt reaches $700 million. Then that level of debt is maintained indefinitely
APV $500 million Debt PV @ 10.53% PV of tax shield = .34x500 operations value debt debt/value
1,839 170 2,009 500 0.25
Interest Coverage $500 million Debt assuming a BBB rating Interest @ 7.72%
38.6
2000 EBITA/i nterest
3.65
2000 EBITA 1999 deprec 1999 deprec + amort 1999 amort = 2000 amort 2000 EBIT
141 585 613 28 113
Interest @ 7.72%
38.6
EBIT/interest
2.93
APV $500 million Debt rf = 5.84% EMRP=6% unlevered beta unlevered return TV perp (g=3%) PV of TV PV of UFCF PV of UFCF & TV % TV PV of tax shield = .34x500 APV = Suez Value D/V
0.59 9.39% 3849 2053 234 2288 90% 170 2458
0.78 10.53% 3266 1620 219 1839 88% 170 2009
0.98 11.70% 2829 1304 204 1508 86% 170 1678
0.20
0.25
0.30
APV with EBITA multiple for TV $500 million Debt rf = 5.84 rm-rf =6% unlevered beta unlevered return TV 6x2006EBITA* PV of TV PV of UFCF PV of UFCF & TV % TV PV of tax shield = .34x500 APV = Suez value
0.59 0.78 0.98 9.39% 10.53% 11.70% 4344 4344 4344 2318 2155 2003 234 219 204 2552 2374 2207 91% 91% 91% 170 2722
* Multiple from Exhibit 9
170 2544
170 2377
PV of Tax Shield Debt of $1 billion Year Debt interest @ 9.18% after tax interest UFCF debt reduction interest tax shield TV of tax shield tax shield plus TV
2000 1000 92 61 109 49 31
2001 951 87 58 -83 0 30
2002 951 87 58 -76 0 30
2003 951 87 58 -2 0 30
2004 951 87 58 173 116 30
2005 836 77 51 237 136 26
31
30
30
30
30
26
PV of tax shield
272
Interest @ 9.18% EBITA/interest EBIT/interest
92 1.54 1.23
2006 700 64 42 278 0 22 238 260
APV Debt of $1 billion $million rf = 5.84 rm-rf =6% unlevered beta unlevered return TV perp (g=3%) PV of TV PV of UFCF PV of UFCF & TV % TV PV of tax shield: init debt $1bill APV =Suez Value
0.59 9.39% 3849 2053 234 2288 90% 271 2558
0.78 10.53% 3266 1620 219 1839 88% 271 2110
0.98 11.70% 2829 1304 204 1508 86% 271 1779
Valuing Operations multiple of EBITA $million
deprec deprec + amort amort 2000 EBIT 2000 EBITA Value of operations @ 7xEBITA Value of operations @ 9xEBITA
1999 585 613 28 113 141 987 1269
Cash to Seagate Shareholders • We now calculate the payments made to Seagate Shareholders – Assume that Suez pays a price that equals one of the values calculated above – Assume that Seagate shareholders pay back $704 million in Debt
Payment to Seagate Shareholders $million rf = 5.84% EMRP=6% unlevered beta unlevered return TV perp (g=3%) PV of TV PV of UFCF PV of UFCF & TV % TV PV of tax shield = .34x500 APV = Suez Value D/V Debt retired Suez value minus debt retired Cash to Seagate shareholders payment to Seagate shareholders
0.59 9.39% 3849 2053 234 2288 90% 170 2458
0.78 10.53% 3266 1620 219 1839 88% 170 2009
0.98 11.70% 2829 1304 204 1508 86% 170 1678
0.20 704 1754 858
0.25 704 1305 858
0.30 704 974 858
2612
2163
1832
Payment to Seagate Shareholders • Seagate shareholders receive – $2,009 million from Suez for Seagate’s operations – $858 million in cash
• Seagate shareholders pay – $704 million = debt retired
• Net payment to Seagate Shareholders – $2,867 million -$704 million = $2,163 million
What do Seagate shareholders Gain from the Stock Swap? • In addition to the net payment shown on the previous slide Seagate shareholders also gain from the stock swap • The next few slides calculate the gain to Seagate shareholders from the stock swap ignoring the previous the cash payment – We first ask how the stock swap should affect the price of Veritas shares
Effect of the Swap on the Veritas Share Price Seagate shareholders Veritas million shares (pre-buyout) Veritas million shares (post buyout) Reduction in Veritas shares (due to buyout)
128 109 19
Veritas Million Shares Total pre-buyout (3/10/00) (exhibit 5) Reduction in Total Veritas Shares Total post swap shares (3/10/00) (exhibit 5)
393.6 19 374.6
Pre-buyout Total Veritas million shares (3/10/00) share price (3/10/00) Veritas Market cap (3/10/00) ($million)
393.6 $168.69 66396
Post buyout Veritas Market cap ($million) Total Veritas million shares implied Veritas share price
66396 374.6 $177.25
Gains to Seagate Shareholders from Stock Swap Seagate million shares (3/10/00) share price (3/10/00) Seagate Market cap ($million)
227.2 $64.25 14598
• Before the buyout, the Market Cap of Seagate was $14,598 million • After the buyout, Seagate shareholders hold 109 million Veritas shares which should each be worth $177.25 Seagate shareholders Veritas million shares (post buyout) Veritas share price (post buyout) Value of Veritas shares ($million) Gain to Seagate Shareholders
109 $177.25 19320
Total Gain to Seagate Shareholders • The gain from the stock swap is $4,722 million • The net payment received in addition is $2,163 million • The total gain to Seagate Shareholders is $4,722 million + $2,163 million = $6,885million
A Good Deal for Seagate Shareholders? • By entering into this deal they would gain $6.885 billion before banking fees • This is almost equal to the $7.149 billion by which Seagate is undervalued, assuming it’s operations have zero value • It clearly exceeds the $2.230 billion they get from the alternative solution if the operations have no value
A Good Deal? • Suppose that the Veritas shares are sold, the debt is paid off and the cash and sale proceeds are used to pay the dividend – If, after this, the market values Seagate’s operations at $2.009 billion then the alternative solution gives the Seagate shareholders $4.239 billion which is still $2.646 million less than the $6.885 billion they realize from the buyout transaction
Gains to Non-Seagate Veritas Shareholders pre-buyout Total Veritas million shares (3/10/00) pre-buyout Veritas share price pre-buyout Veritas Market cap ($million) pre-buyout Non-Seagate Veritas million shares pre-buyout Value of Non-Seagate shares ($million) post buyout Vetitas million shares post buyout Non-Seagate Veritas million shares post buyout Veritas share price post buyout value of Non-Seagate shares ($million) Gain to non-Seagate Veritas owners ($million)
393.6 $168.69 66396 265.6 44804 374.6 265.6 $177.25 47077 2273
Gains to Non-Seagate Veritas Shareholders • Before the buyout 265.6 million Veritas shares owned by non-Seagate shareholders – Because buyout reduced the total number of Veritas shares by 19 million, the price of those shares should have increased by $8.56 from $168.69 to $177.25 – That would increase the value of the 265.6 million non-Veritas shares by $8.56x 265.6 million = $2,273 million
The Total Gain • The $2,273 million of gains to the nonSeagate Veritas Shareholders plus the $6,885 million that the Seagate Shareholders gain equals a total gain $8,158 million = $7,149 million + $2,009million
Source of the Gains • Recall that – $7,149 million is the undervaluation of the Seagate’s shares assuming the operations have no value • So part of the gain comes from eliminating the undervaluation of the Veritas shares held by Seagate
– $2,009million is the price paid for the operations • The rest of the gain comes because this value is obtained for Seagate’s operations
What Happened $million Actual outcome Suez price Cash to Seagate shareholders debts paid by Seagate shareholders gain to Seagate shareholders gain net of other costs Stock swap gain to Seagate total gain
2,000.00 858.00 1,200.00 1658 950.00 4,722.11 5,672.11
Was the Actual Deal Good for Seagate Shareholders? • The actual deal gave them $5.672 billion • Recall that Seagate could have achieved some of this value by the selling the Veritas shares – Suppose that after the share sale and dividend payment Seagate’s operations are valued at $2 billion. – Then the share sale and dividend would have given them $4.230 billion. So they only gained $1.442 billion more from the buyout
Why Seagate’s Shareholder’s Gains were Reduced • The gains to Silver Lake come at the expense of Seagate’s Shareholders who paid off almost $500 million in additional debt (apparently accounts payable) • Seagate’s shareholders also make less on the deal because of the approximately $700 million in other costs (fees) they incur
The Division of the Gains
$million Non-Seagate Veritas Gains Seagate gains Silver Lake gains banker's fees total gains = tax liability*
2,273 1,442 496=1,200-704 708=1,658-950 4,919
* See Slide 6
