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Seagate Technology Buyout Case Solution & Answer

Seagate Technology Buyout Case Solution

Introduction

This case is about Seagate Technology based in America. It was established in 1979. The company provides data storage services to its clients. It is considered as a market-leading manufacturing company for hard drives. The problem arose for the company when the management decided to buy-out and their issues were: deciding an amount to pay for the company’s operating assets, finding out an accurate financing for the buyout transaction, the company’s low stock price and the required rate of return from buy-out.

Therefore, the current credit rating of the company is BBB, and the company needs to maintain this credit rating. This is because the company has set aside the total assets of $7,072 million as collateral to maintain this credit rating, with the current level of debt.Moreover, the company can take benefit from the tax shields that will arise from the payment of interest expenses by the company. According to the cash flows; the PV value is positive, i.e. $427.16 million. The buyout consists of two different stages transactions, which include a leveraged buyout of the disk drive operations and a tax-free stock swap with VERITAS. This option will benefit Seagate to address its low stock value. Secondly, it will also benefit Seagate to offload its VERITAS shares, without undergoing a significant tax liability.

Key Issues for bay-out

The issue occurred for the company in March 2000, when a group of investors and senior managers of a company were negotiating on the acquisition of the disk drive operations. The factor that led the company to opt for the buyout, was the unexpected market value of equity. The issues were more complicated to resolve, because of the capital intensive industry where the company operates as well as the industrial volatility rate. The issues regarding Seagate’s buyout, were:

  • The investor’s decision for the amount to pay for the company’s operating assets.
  • Financing decision for the buyout transaction.
  • The company’s low stock price.
  • The required rate of return from buy-out.

Q1: What is the expected return on assets on Seagate’s disk drive business?

The expected return on assets based on the assumptions is calculated by CAPM Model. According to the CAPM model; the expected return on asset is calculated as 16.16%. However, the data used for determining return are: market risk premium (as given for the mature market of US) as 8.6%, risk-free rate(30 Year Government yield) as 5.84%, and equity beta as 1.2.

 

The calculation for CAPM (Expected return on assets)
Risk-free rate (30 Year Government Yield) 5.84%
Equity Beta 1.2
Market Risk Premium(as given for the mature market of US) 8.60%
Cost of Equity 16.16%

 

Q2: Find the value of the disk drive business using the Enterprise value method (i.e., a WACC-based calculation). This requires you to determine the free cash flows and the WACC (and therefore, the cost of debt and the cost of equity).Assume that:

(i) An 80% debt to value ratio will be maintained.

(ii)The risk-free rate is 6%.

(iii) The risk premium is 7%.

The projections that have been provided in exhibit 8 regarding the future operating performance of Seagate’s disk drive business, have been used to calculate the value of Seagate’s………………

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