Seagate Buyout Case Study Essay

(d) $1 billion 10 year debenture @ 7.5% with 18.18 warrants at $ 55 exercisable until 1988.

This happens through a down-stairs merger. The remaining shell would be merged with Veritas and in exchange Seagate existing shareholders are distributed new Veritas shares proportionally. This unlocks the value of the shares without facing double taxation through the corporate tax of 34%. The existing shareholders only incur a personal capital gains tax on their investment holdings. The purpose of this part of the transaction is to successfully deliver the maximum amount of value from the appreciation of the Veritas stake to Seagate’s existing shareholders.

In case they finance with debt, Winfield (the company) would be able to enjoy the tax shield as a result of tax deductible interest expense, hence their effective cost of debt will be 4.225%. However, when financed with stock, the new stockholders will be entitled to perpetuity of $7.5M in dividends. Working out the net present values of the two scenarios as shown in the tables above, Debt financing becomes a favorable option to stock since it yields a higher NPV.

4. The case indicates that the company’s “market value” of equity at June 30, 1999 was $460 billion. Compare this to the company’s “book value” of equity. What factors likely explain the difference between these two values?

a) How many shares will the firm have to issue, assuming they issue the new shares at the current price per share?

2. Forecast the firm’s financial statements for 2002 and 2003. What will be the external financing requirements of the firm in those years? Can the firm repay its loan within a reasonable period? In order to forecast the financial statements of 2002 and 2003, the following assumptions need to be made. The growth of sales is 15%, same as 2001, which is estimated by managers. The rate of production costs and expenses per sales is constant to 50%. Administration and selling expenses is the average of last 4 years. The depreciation is $7.8 million per year, which is calculated by $54.6 million divided by 7 years. Tax rate is 24.5%, which is provided. The dividend is $2 million per year only when the company makes profits. Therefore, we assume that there will be no dividend in 2003. Gross PPE will be $27.3 million (54.6/2) per year. We also assume there is no more long term debt, because any funds need in the case are short term debt, it keeps at $18.2 million. According to the forecast, Star River needs external financing approximately $94 million and $107 million in 2002 and 2003, respectively. In order to analysis if the company can repay the debt, we need to know the interest coverage ratio, current ratio and D/E ratio. The interest coverage ratios through the forecast were 1.23 and 0.87 respectively, which is the danger signal to the managers, because in 2003, the profits even not

Scenario 3 shows us what would happen if he fails and looses market share. According to the case, Miller would make the visit to the dentist more pleasurable and stress-less. The only way this scenario can happen is if new competition come in or he does a bad job in fixing teeth. Just to show the “worst case scenario,” I set growth rate at 0% and the rest of the years decline 5%. We would hope that after declining of sales, Miller would liquidate the firm in 2009. As we can see, change in working capital is increasing as sales are decreasing, which means he can’t pay off the debits. If we look at the cash flow forecast, if Miller decides to liquidate the firm in 2009, then the book value of the fixed assets would be 14,836 and the salvage value would be 10,385. This scenario is unlikely to occur

Solutions to Valuation Questions 1. Assume you expect a company’s net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company’s β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the company’s equity cost of capital. • re = RF + β * (RM – RF) = 0.05 + 1.5 * 0.04 = 11% b. Compute the expected net distributions to stockholders for each future year. • D = NI – ΔCE = $1,100 – 0 = $1,100 c. Use the

Issuing 3 billion dollars of new debt to pay dividends should not have any effect on the voting control of the Wrigley family. Using that money to buy back shares will have an effect on the voting right of the family. When shares are repurchased they are put in the company treasury and are no longer outstanding. Then the Wrigley family’s percent of outstanding shares would rise

o If too low, Seagate shareholders will not receive the full value of their investment

Under the agreement, which has been unanimously approved by both boards of directors, VERITAS stock will be converted into Symantec stock at a fixed exchange ratio of 1.1242 shares of Symantec common stock for each outstanding share of VERITAS common stock. Upon closing, Symantec shareholders will own approximately 60% and VERITAS shareholders approximately 40% of the combined company. The transaction is expected to be tax-free to shareholders for U.S. federal income tax purposes.

Questions 1. If Symonds Electronics Inc. were to raise all of the required capital by issuing debt, what would the impact be on the firm’s shareholders? The impact on shareholders can be analyzed by calculating the EPS and ROE of the firm under the alternative scenarios as follows: All Debt With $5,000,000 Expansion Current Growth in Revenues Revenues EBIT Interest EBT EBT*(1-T) # of shares EPS Debt Equity Debt/Equity Ratio Return on Equity 15,000,000 2,250,000 0 2,250,000 1,350,000 1,000,000 1.35 0 15,000,000 0.00% 9.00% Worst Case 10% 16,500,000 2,475,000 500,000 1,975,000 1,185,000 1,000,000 1.185 5,000,000 15,000,000 33.33% 7.90% Expected Case 30% 19,500,000 2,925,000 500,000 2,425,000 1,455,000 1,000,000 1.455 5,000,000 15,000,000

1. Why is Seagate undertaking this transaction? Is this necessary to divest the Veritas shares in separate transaction?

In the future, SELF will be able to set limits on their cost of debt, by using some of the available alternatives (see next chapter). Furthermore, we know that the limits on the debt ratio are 4 to 1, in comparison with the net worth of SELF. Interpreting this, we assume that SELF may have a maximum of 80% debt, with 20% equity in their capital structure (4 to 1). The current Prime-rate is 8,75% and will be used as a basis to calculate the possible WACC for SELF. Assuming that the debt rates are before tax, we will subtract a tax rate of 30% on the debt rates, resulting in:

No, $9/share is too low. DCF analysis shows value of company at $22.3MM (assumes 6% stable growth and 8.92% WACC) which equates to $96/share vs. implied value of $9.6MM based on $9/share offer price. Additionally, at that price, $7.5MM in proceeds equates to 833,333 shares and 78.15% of company. If a higher offer price were received, the existing shareholders could limit the dilution of their interests. Lastly,