Seagate Technology Buyout
May 3rd, 2023
Ram Lal
Founded in 1979, Seagate Technology is involved in the business of designing,
manufacturing and marke=ng of a range of disk drives that are ul=mately integrated in
various products, categorized in three markets: Desktop (desktop personal computers),
Enterprise (worksta=ons, minicomputers, servers), and Mobile (Laptop computers,
personal digital assistants). Currently, Seagate is the market leader in the worldwide disk
drive business with total market share of 21% and annual revenues of $7 billions. Being a
ver=cally integrated en=ty, Seagate spends heavily on R&D and capital expenditure, and it
believes that this integra=on enables it to benefit from having control over new cuRngedge technologies by developing them in-house, manufacturing process by increasing
produc=on in a response to surging demand, and inventory levels of disk drive
components by not relying on its suppliers’ ability to provide the greater quan==es of
components in =mes of high demand.
Originally, Seagate received 155 million VERITAS’ shares of stock a[er it sold its Network
and Storage Management Group (NSMG) to VERITAS and became its largest shareholder
with over 40% stake. In following few months, VERITAS stock price went up drama=cally
(over 200%), but due to the market not realizing the poten=al of Seagate’s stake in
VERITAS as well as of its disk drive business, Seagate stock price increased by only 25%,
resul=ng in the market value of Seagate’s stake in VERITAS to be higher than that of
Seagate’s en=re equity. To improve its stock price, Seagate sold some of its stake in
VERITAS in the market and repurchased some of its shares. As both the ac=ons failed to
bear any result, Seagate is now considering a proposal from Silver Lake undertake a twostep transac=on for selling its disk drive business, along with $765 million cash, to a newly
formed company, Suez Acquisi=on Company, and, subsequently, merging with VERITAS
with its remaining assets (proceeds from buyout, stake in VERITAS and few equity
investments). In order to mone=ze the VERITAS shares, Seagate can either distribute the
VERITAS shares to its own shareholder or sell VERITAS shares in open market and then
distribute the cash to its shareholders. However, both ac=ons will result in a huge tax
liability on both corporate and personal level. Therefore, dives=ng VERITAS shares in a
separate transac=on is necessary to avoid such liability as the merger with VERITAS will be
through a tax-free stock swap.
Purchase of Seagate’s disk drive business by the newly formed company will be financed
through a leveraged buyout (LBO). The major benefit of this form of financing is that
investors’ own capital is very small, and the buyout is financed largely through debt which
is backed by target company’s assets. Over =me, the cash flows from the sale of assets
and opera=ng ac=vi=es are used to repay the debt and reduce the financial leverage.
Currently, instability and unpredictability of cash flows due to intense price compe==on
and short product life cycles as well as huge cash ouelows required for R&D and capital
expenses seem to make this transac=on conserva=ve (less conserva=ve). However, Silver
Lake team believes that future prospects of disk drive industry are lucra=ve, and Seagate’s
financial posi=on will further consolidate once it re-enters into Mobile segment and
benefits from SAN and NAS storage networking opportuni=es. Hence, Silver Lake will
heavily benefit from the value crea=on post-buyout. Seagate’s shareholders will benefit
from the cash and tax-free VERITAS stock distribu=on as well as the fair market value
received from the sale of disk drive business. VERITAS shareholders should find this
proposal afrac=ve as its stock price will not experience a dip as the shares are not being
sold, rather being swapped. Moreover, there will be fewer shares outstanding, which will
increase its share price. The only party we believe will be at a disadvantage is the minority
shareholders of Seagate as its shares will illiquid a[er the buyout.
Using base case projec=ons, amor=za=on and net working capital are es=mated to be
1.75% and 26% of revenue, respec=vely, and assuming tax rate of 40%, free cash flows to
the firm start turning out to be posi=ve and growing a[er first three years (Exhibit 1).
Assuming 0 debt beta and using given capital structure data (as of March 2000) and
levered equity betas of peer firms, the average unlevered equity beta is calculated to be
0.69 (Exhibit 2). Keeping in mind the going concern concept, it is assumed that Seagate
will keep opera=ng indefinitely even a[er being taken private and, therefore, 30-year
government securi=es rate, 5.84%, has been used as the risk-free rate in the calcula=on of
unlevered cost of equity. Market risk premium is es=mated to be 7% and, using CAPM
model, unlevered cost of equity is 10.65% (Exhibit 3).
Seagate’s debt ra=ng un=l March 2000 is BBB and, hence, we assume that the buyout
team will be able to raise the debt at 7.72% (the corresponding market interest rate as per
market interest rates data in Exhibit 4). Using this interest rate and resultant interest
coverage, we have tried to assign a ra=ng, as per S&P key industrial coverage data in
Exhibit 5, to Seagate’s debt for each year throughout the projec=on period for three
different levels of debt; $500m, $1b, $1.5b (Exhibit 6). The average ra=ngs for $500m, $1b
and $1.5b are AA, BBB and BB, respec=vely. At debt level of $500m, Seagate can maintain
an investment grade ra=ng of BBB or befer from 2002 which will enhance the possibility
of future financing. However, if it borrows $1b, it will only be able to maintain a ra=ng of
BBB or befer from 2004 which is consistent with our calcula=on of free cash flows
(nega=ve for first three years). Using solely the average ra=ng for projec=on period, it will
be preferrable for buyout team to use $1b debt in its capital structure.
We have employed two approaches to value Seagate’s opera=ng assets. For first
approach, WACC method, it is assumed that Seagate will maintain a debt-to-value ra=o at
50% and the cost of debt will be 9%. Furthermore, it has been assumed that free cash
flows will grow at a long-term growth rate of 3%. Using this data, along with earlier
calculated unlevered cost of equity, we have calculated a weighted average cost of capital
(WACC) of 8.85% (Exhibit 7). The terminal value at the end of 2008 using the WACC is
$4.76b and total value of the levered firm at the end of 2000 is $2.96b (Exhibit 8).
For second approach, APV method, it has been assumed that the Silver Lake’s buyout
team will finance the buyout with $1b debt at the cost of 8%. Posi=ve free cash flows will
be used to repay the debt and nega=ve cash flows will be replaced with addi=onal debt.
The year-end debt level will used for the calcula=on of interest expense for next year. In
any year, the debt level will not fall below $700m and this level will be maintained
perpetually at the end of 2006. To value the firm using APV approach, we have used the
unlevered cost of equity to calculate the terminal value at the end of 2008 ($3.64b) and
then discount the free cash flows along with the going concern value. We have calculated
the value of the unlevered firm to be $2.1b (Exhibit 9). Interest tax shield has been
calculated by mul=plying the interest of a given year by the tax rate and, as the firm will
maintain a perpetual debt level of $700 at the end of 2006, interest tax shield in the year
2006 includes ITS of that year as well as present value of ITS resul=ng from maintaining
the perpetual debt level. The present value of interest tax shield has been es=mated to be
$0.37b and the total value of levered firm is $2.47b (Exhibit 10).
Exhibit 1
Exhibit 2
Exhibit 3
Exhibit 4
Exhibit 5
Exhibit 6
Exhibit 7
Exhibit 8
Exhibit 9
Exhibit 10