Sealed Air Corporation Case Study
Ryan Mills, Prashant Sahu, Xingzhi Zhou, Jianzhong Wang
Sealed Air Corporation has historically been a very successful company with a near monopoly in its business sector. Sealed Air owned many patents, although many were set to expire soon. Having become complacent, Sealed Air had completely overlooked the efficiency of its manufacturing process, assembly line and supply chain.
However, because of the increase in competition in the US and Europe, Sealed Air reacted by introducing the World Class Manufacturing concept. In the late 80s, Sealed Air’s stock prices had depressed and did not seem to be improving in the near future. The managers had a problem with managing the large amount of cash lying on the balance sheet. (Sealed Air had $50m in cash and short- term investments, which were expected to double in few years).
The reasons behind the recapitalization decision by Sealed Air management were: a. The excess free cash flow, which had tempted the managers to waste money on substandard projects. b. Sealed Air did not have good investments or M&A opportunities c. They had sufficient capacity in their plants to meet future demand, without significant additional capital expenditure d. They had been generating sufficient cash flow from operations to ensure sustainable growth
Given the circumstances, the leveraged recapitalization was an excellent financial maneuver for a variety of reasons: a. It provided the cash required for the large dividend payment. Since the company did not have good projects to invest in, it was a good idea to give back the money to the shareholders so that the money could be invested in higher return projects. b. It substantially reduced the WACC for Sealed Air.
c. This move was in line with the recent adoption of the World Class Manufacturing philosophy. By a simple financial decision, Sealed Air was able to create a ‘crisis’, which disrupted the status quo and drove internal change. It provided an opportunity to completely overhaul the current manufacturing process, company’s long-term vision and mission, and the capital budgeting process.
The leveraged recapitalization of Sealed Air was a good move for the company, the creditors, and the shareholders alike. The company could reset their priorities and put the customer first, set a cash flow objective, carry fewer inventories and work in process, and focus on innovation.
There are 2 approaches to estimate the value created:
a. Present Value of Tax Shields created due to leveraged recapitalization
In this approach, we first found the tax rate using the EBITDA and the tax expenses. The tax rate was found to be 35.25% for 1989. PV (Tax Shields) = Tax Rate * Amount of Debt
b. The second approach to find the expected value created is using the past and present stock prices.
Prior to the recapitalization, the Sealed Air stock traded between $44.125 and $45.875. The average stock price during this period can be found to be $45.
After a dividend payment of $40 per share, the expected stock price should have been ($45-$40) = $5. However, at the end of 1989, the stock was trading at $20.375.
Value worth ($20.375-$5) = $15.375 was created per share.
So total value created = value per share * number of outstanding shares
= 8.245m * $15.375
This created value can be attributed to the signaling effect created due to the leveraged recapitalization, and the subsequent re-alignment of Sealed Air’s objectives and vision along the lines of World Class Manufacturing.
In summary, we took two approaches to get the value created. The first is quantitative in nature and reflects the benefit of the tax shield after recap. The second approach calculates the value added from the perspective of shareholders, not only because of the change in capital structure, but also attributed to...
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