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Seagate Buyout March, 2000

Seagate Buyout

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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 34.6 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. aIncludes mobile. bAmount is not material.

Seagate Buyout

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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 Drive Industry Historical Performance and 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

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 Buyout

187.8 13.2%

2001E

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Seagate: ‘90’s • ’92-’99 Average revenue growth of 15.9% – ‘92-’99 average industry revenue growth of 1%

• ’90’s Average EBIT margin of 6.7% – ‘92-’99 average industry median EBIT margin of 2.6% Seagate 1990 2413

Sales ($ million) % Growth EBIT ($Million) % Sales

179 7.40%

Disk Drive Industry Medians EBIT as % of Sales

5.9%

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%

4.3%

From Exhibit 2

5.9%

-0.3%

-2.4%

Seagate Buyout

1.9%

3.9%

1997 8940 4.1%

1998 6819 -23.7%

1999 6802 -0.2%

1020 -138 11.40% -2.00%

398 5.90%

7.5%

-1.4%

1.1%

Average 15.9%

6.7%

2.6%

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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 Buyout

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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 Buyout

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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 Buyout

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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 Seagate Buyout

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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

Seagate Buyout

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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 Buyout

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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

Seagate Buyout

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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 of Seagate’s shares Seagate Buyout

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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 Seagate Buyout

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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

Seagate Buyout

21592 14467 4919 16674

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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

Seagate Buyout

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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

Seagate Buyout

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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

Seagate Buyout

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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 Seagate Buyout

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

Seagate Buyout

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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 Seagate Buyout

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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 Seagate Buyout

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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? Seagate Buyout

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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?

Seagate Buyout

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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

Seagate Buyout

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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

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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

Seagate Buyout

avg

22%

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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 revenues Seagate Buyout

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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 Seagate Buyout

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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

Seagate Buyout

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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

Seagate Buyout

6% 5.84%

236 -154 670

0.35 0.26 9.18% 0.6 0.56 0.59

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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

Seagate Buyout

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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%

Seagate Buyout

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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 Seagate Buyout

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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

Seagate Buyout

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Interest Coverage $500 million Debt assuming a BBB rating Interest @ 7.72% 2000 EBITA/interest

2000 EBITA 1999 deprec 1999 deprec + amort 1999 amort = 2000 amort 2000 EBIT Interest @ 7.72% EBIT/interest

38.6 3.65

141 585 613 28 113 38.6 2.93

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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

Seagate Buyout

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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

170 2544

170 2377

* Multiple from Exhibit 9 Seagate Buyout

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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

2006 700 64 42 278 0 22 238 260

92 1.54 1.23

Seagate Buyout

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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

Seagate Buyout

0.78 10.53% 3266 1620 219 1839 88% 271 2110

0.98 11.70% 2829 1304 204 1508 86% 271 1779

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Valuing Operations multiple of EBITA $million

deprec deprec + amort amort 2000 EBIT 2000 EBITA Value of operations @ 7xEBITA Value of operations @ 9xEBITA

Seagate Buyout

1999 585 613 28 113 141 987 1269

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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

Seagate Buyout

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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

Seagate Buyout

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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 Seagate Buyout

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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 Seagate Buyout

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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

Seagate Buyout

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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)

109 $177.25 19320

Gain to Seagate Shareholders ($milliion)

Seagate Buyout

4722 =19320-14598

46

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

Seagate Buyout

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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 Seagate Buyout

48

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 Seagate Buyout

49

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)

Seagate Buyout

393.6 $168.69 66396 265.6 44804 374.6 265.6 $177.25 47077 2273

50

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 Seagate Buyout

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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

Seagate Buyout

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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 Seagate Buyout

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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

Seagate Buyout

2,000.00 858.00 1,200.00 1658 950.00 4,722.11 5,672.11

54

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 Seagate Buyout

55

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 Seagate Buyout

56

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

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The Debt Structure of the Deal • Silver Lake financed the deal with $1.3 billion in debt so the debt to value ratio was initially about 65% • $700 million of this debt was term loans which matured in 5 and 6 years • The senior debt which matured in 2007 was rated B1 by Moodys

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