Sealed_Air

INTRO Sealed Air Corporation's leveraged Recapitalization is a strategy where a company takes on significant additional debt with the purpose of paying a large dividend. The result is a far more financially leveraged debt ratio, which is called "optimal" debt capacity. This technique can be used, and has been used, as a "shark repellant" to ward off a hostile takeover. This is done by adding debt, eliminating idle cash and debt capacity. Sealed Air had traditionally neglected manufacturing in favor of marketing, they were able to do this because of a lack of competition, however mid-1980s increased competition and expiring patents on products. Sealed Air reacted to this increasing competition by introducing the WCM-World Class Manufacturing program, which promoted manufacturing excellence. This increased their cash and debt capacity. Competitors were marketing cheap imitations of Sealed Air’s products by inventing around SA’s manufacturing process patents. Sealed Air Corporation’s leveraged recapitalization was a good idea in the context of its changing competitive environment. Competitors were producing the products previously patented by Sealed Air in abundance and were selling them for a cheaper price. Sealed Air stock price in 1989- stock seemed to be undervalued because they has a lot of free cash flow which tempted the company to waste money. It was depressed and did not seem to be improving in the near future. Sealed Air had a problem with managing their cash, Sealed Air had 50 million in cash and short term investments and the cash on hand as stated in the case was expected to double in the next year. CONCLUSIONS AND RECOMMENDATIONS The market value was created by the recapitalization of Sealed air. The various events at which market cap increased due to the recapitalization is shown at Exhibit 1. At one point in time the market value advantage was $141 million when the stock price was at a maximum of $23. The share price did not fall ex divided as much as the dividend payout. The large part of the value has come because the market is valuing the price and advantages of tax shields from the substantial debt that the company has undertaken as part of the recapitalization process. Exhibit 2 shows that on the Ex-Dividend Date, the market value of Sealed Air's equity increased 54.7 million from the day before announcement of recap. At the end of 1989, the value had increased 119.6 million. 

I use adjusted present value method to calculate how much value was created.

VL = VO + TC D - f(D)= VO + TC D - (probability of bankruptcy* cost of bankruptcy)

= VO + TC D - (probability of bankruptcy*'* VO)

VL1 = Market Value of Equity + Book Value of Debt = 8.245*45.875+ 35.5 = 378.24+35.5= 413.74

VL1 = VO + TC D1 - f(D)1 VO = VL1 -TC D + f(D) = 413.74 - 35.5*35% = 401.32. 

I ignored the f(D)1 because the amount of debt before recapitalization is so small that the probability of bankruptcy and the cost of bankruptcy are small as well.

EBIT Interest coverage ratio = 53.7/17.1 = 3.14. 

EBITDA interest coverage ratio = 69.9/17.1 = 4.08. Long-term debt/cap = 65%. 

Cash used to pay dividend is 21.3 million

VL2= VO + TC D2 - f(D) 2= 401.325 - 21.3 + 35%*311.1 -19.28%*20%*378.24 

= 380+108.885 - 14.585= 474.3

VL2 - VL1=474.3-413.74 = 60.56. 

Therefore, the tax shield with increasing debt ratio created 60.56 million. In addition, this result is close to the market response 54.7 million. In Exhibit 3 and Exhibit 4, it is shown that can the EBIT and cash EBITDA are larger than the total expense. Therefore, we have sufficient evidence to prove the company can successfully renegotiate with the bank about the covenant. In a study conducted by Morgan Stanley on 25 leveraged recapitalizations from 1984 to 1990. The different ways in which shareholder value has been created are: • Initial Cash Distribution: The first day distributions averaged 98% of pre announcement value of equity. • Once the transaction closed, many firms immediately began to trade at higher EV/EBIDTA multiples. Over a third of the firms saw multiple expansions, with valuations rising 42% on average. • Management Compensation: Management and employee ownership stakes increased in 70% of the deals. The average management stake doubled to roughly 15% after the deal. Sealed Air value was created from necessity of repaying their loan, the restrictions that were placed on the company as a whole, and the positive changes that resulted from the financial " crisis" because of it. For those individuals who held SEE stock at the time of the payout, there was a lot of value in that they received a dividend that equated to an 87.19% return on their investment. For those who could, and did hold on to their stocks, the price did drop to a low of $12.50 per share but when you take into account that: Original Price 45.875, Dividend Payout 40.00, Price per share 5.875, Low Price 12.50 Filtering through this it appears that if you held SEE stock and had purchased it at the price on the day of the dividend payout, they refunded you $40 of the 45.875 price and it had a market value of $12.50. This equates to a 112.77% return on the investment if you sold it at the low price. After the new dividend payout policy was implemented, Sealed Air would have a debt-to-book value ratio of 1.36 and negative net worth of $160.5 million, while the future cash flow is uncertain, this change will drastically heighten the financial leverage ratio as well as the risk faced by investors. 

So, under the circumstances, conservative investors who are more risk averse tend to sell the stock to the recap because they prefer to invest in companies with stable return, growth and limited risk. But speculative investors who are more risk preferred tend to hold the stock because they are willing to look beyond the negative equity and cash flow projections from which they may look for significant gains in profitability. So Sealed Air's investor base turnover completely changed after the recap

. Managers totally should be concerned about this. Because the speculative investors hold the company's stocks chasing for significant gains in profitability, they care only about the short term profit which will leads to the price fluctuation and further increase the risk face by the company. For the stockholder, this was a good investment. SEE ended up with a negative net worth but since that time they have continued to grow and even began paying dividends again in 2006. Pursuing a program of manufacturing excellence such as world-class manufacturing is not necessarily inconsistent with levering up. After the implementation of WCM, Sealed Air had more in cash and effectively motives the employee. The main lesson of WCM is that if you do it right you can have it all- high quality, low cost, fast and dependable customer service and reduced working capital. Sealed Air at all levels and at all locations is dedicated to achieving WCM through total quality, just-in-time inventory, total material usage, total preventative maintenance and employee involvement. WCM will automatically stimulate innovation throughout the company, which will help to produce a steady flow of new products and new ways of operating our business and serving the customers. On the other hand it does not help low cost or the high quality aspects of the equation. Because of the constraints put on Sealed Air's capital expenditures, it will be more difficult for them to invest in new equipment that could aid them in producing the highest quality products at the lowest cost and in turn be more responsive to the customers. The management had purposefully and successfully used the leveraged recapitalization as a watershed event. The main reason of creating such a crisis was to disrupt the status quo and to promote internal changes in the company. Thus after recapitalization the most important thing was the need to reestablish whole new objectives, change the compensation systems, and reorganizing manufacturing and capital budgeting processes so as to realign the organizational behavior of the company to meet the leverage's desired disciplinary effect. 

A key indicator of whether leverage is having the desired disciplinary effects is the post-recap balance sheet progress. The large overhang of debt service obligations galvanizes management to improve operational performance thus generating sufficient cash flows to pay down the debt. Thus the management's priority was to put the their customers first and a their cash flow objective was redefined in such a manner that it took care simultaneously to increase sales and margins, have less inventory, less capital expenditure and faster collection. 

With the objectives clearly spelt out, the new bonus plan and new employee stock ownership was introduced so as to serve as an act of extrinsic motivation for the employees to work towards their objectives. A leveraged recapitalization by Sealed Air Corp in my opinion was a good idea because the corporation has reached a stage where they have adequate manufacturing capacity to meet the demand for its products during the next several years without significant additional capital expenditure. Moreover they have generated more than sufficient cash flow from the operations to support the growth of their operations and capital expenditure. The recapitalization is good for both the Sealed Air as well as the investors. By using the leveraged recapitalization the management created a crisis that disrupted the status quo and promoted internal change, which included establishing a new objective, changing compensation systems, and reorganizing manufacturing and capital budgeting processes. It gave the firm and the employees the opportunity to analyze the concept of free cash flow, its effect on stock market prices and firm value, and the disciplinary role of high leverage. For the investors it is good because the special dividend payout would give them the amount which they can invest in some other growth stock and expect a good return which the Sealed Air Corp is not able to give in the present scenario and still be a part of the firm by holding the stocks of the firm. INDUSTRY ANALYSIS Sealed Air is a leading global innovator and manufacturer of a wide range of protective packaging. It has widely recognized brands such as Bubble Wrap cushioning, Jiffy protective mailers, Instapak foamin-place systems and Cryovac packaging technology. Sealed Air continues to identify new trends, and deliver innovative solutions to its customers in 51 countries. In the fast paced technology industry, Sealed Air must ensure the continuous flow of information through all levels of the supply chain. The protective packaging industry can be segmented three ways by use: positioning, block, and bracing; flexible wraps; and void fill. Coated and uncoated air bubble products serve the flexible wrap and void fill markets. US consumers have traditionally viewed packaging supplies as a cost-saving resource. Consequently, packaging engineers are accorded high status and influence roughly 40% of material purchase decisions. The US market is experiencing strong growth, driven in part by the growth of the coated and uncoated bubbles segment. However, Sealed Air market share remains stagnant. It is apparent that a growing segment of end users are willing to forgo product quality for a lower price. European firms, in particular, are price conscious and less technically oriented; many firms view packaging supplies as expendable commodities. This has enabled manufacturers of technically inferior, inexpensive uncoated bubble to co-opt AirCap customers with increasing success. Sealed Air faces both direct and indirect competition in the flexible wrap market. Astor Packaging is the only other producer of coated bubbles in the US; it also serves the low-end of the market with uncoated bubbles. GAFCEL recently began manufacturing uncoated bubbles in the eastern US, and has gained access to several Sealed Air distributors. In Europe, Sansetsu has substantial sales for its high-quality uncoated product. Despite the lower price of uncoated bubbles, the above competitors each have strategic weakness that leave them vulnerable to a strategic attack by Sealed Air should it enter the uncoated segment. Astro is limited by the fact that it is a Sealed Air licensee and manufacturers an inferior product. As a small producer, GAFCEL lacks a regional presence beyond New York State. Similarly, Sansetsu lacks the financial resources and global reach of Sealed Air. Indirect competition stems from paper-based products (e.g., cellulose wadding), and foams (e.g. polyurethane.. Sealed Air's strengths lie in its technological leadership, which include a number of manufacturing process patents. The company has a strong global presence, and owns SIBCO, the only marketer of uncoated bubbles in France. The company has a consumer orientation, strong sales, loyal distributors, and a knowledgeable commission-based sales force that specializes in consultative selling. Sealed Air's weakness includes a product portfolio that excludes uncoated bubble and is so broad it overburdens its sales personnel. The prime opportunity in the market is for the company to leverage its strengths to enter the uncoated bubble segment. The rapid displacement of coated by uncoated bubble constitutes a salient threatThe SWOT Analysis Strengths • The company is enjoying the market leadership position. The market leadership position include the first mover advantage, elaborate distribution system, highly effective managers, large customer base as well as proper product knowledge and industry knowledge • The company uses a business model that fits the competitive environment. For example, the company believes in strengthening its operations in the highly profitable countries while conducting researchers in emerging economies. Weakness • The company is relatively disadvantaged because of its reliance on the European and the American market. The company relies on the profits from one segment more than the other. Sales are also the key company’s source of revenue and the same sales are abussed by its competitors. • The company is also penetrating on very few business segments that are highly concentrated instead of considering the products geared at the bottom of the pyramid where the critical mass is highly accessible. Opportunities • The increase industrialization is a source of opportunities of the company. There are many rising companies that will demand. There is limited scope of opportunity for the company is the US, and increased market opportunities in the UK, Asia, and South Africa for the coated bubble packaging market and hygiene solution. Others include large market for uncoated bubbles Threat • The company is currently threatened by the presence of aggressive competitors as well as the fall in the demand for sealed air products. • Number of legislation governing the manufacture of packaging products that limit the range and quality of materials used in the manufacturing packaging products • The market is also limited by the distribution channel as well as distribution and spread of the manufacturing facilities around the world. Gafcel is a key threat to the company in the US MANAGEMENT Sealed Air Corporation has a corporate history, which has been characterized by technical accomplishment and market leadership. The company has chosen a strategy of differentiation from its competitors and has not been afraid to take the path less trodden amongst its competitors. In essence, the company aims to use its expertise in technology by differentiating itself from its competitors because it is the only long-term guarantee of market leadership. Further, the company has a strong set of core values, which it has consistently been following through with. The president and CEO of the company has come out with a statement saying that the company intends to follow the same management guidelines it has been through the 1970’s in the 1980’s as well.