This is another missive on corporate governance issues, which are coming to a head fast and furiously in light of the severe value dislocations in today's financial environment.
The subject is
, whose well-publicized "problem" is that a few years ago it sold its software division to
in exchange for one-third of Veritas' stock. The value of that holding was worth some $20 billion upon the deal's announcement, putting another crack in the efficient market wall, as Seagate's total market cap was only $17 billion or so.
Last week, Seagate announced it has
solved this problem, by going private in a very elegant and tax-efficient method. The disk-drive operations will be sold to management and its backers, including the very busy
Silver Lake Partners, for $2 billion in cash. Veritas gets to buy its shares held by Seagate at a 15% discount, and takes over the remaining Seagate corporate shell, which has a billion or so in cash and assorted securities.
Kudos to the investment bankers and lawyers who designed this slick transaction that makes the score Silver Lake Partners, 2; shareholders, 0. But the real problem here is that the proposed solution is for management and its backers to capture most of the value that should belong to shareholders.
Now, there is no law that specifies that a company shouldn't be taken public at the highest price possible. There is also no specific law that states that a company can't be bought out at the lowest price possible.
There is, however, a whole set of laws and obligations that fiduciaries like boards of directors and senior management teams assume when they agree to take on the responsibility to maximize the value of a company's assets and cash flow for
of its shareholders. The Seagate deal appears to fall into a gray area as to whether shareholders are being treated fairly, as do a number of other contemplated transactions:
Cameron Ashley Building Products
The main issue is as follows: By definition, how can a management-led buyout of a publicly held company
be a violation of fiduciary responsibility? Management has all of the pertinent operating information that outside shareholders will never have, and thus is in the most informed position to take a stab at what the intrinsic value of a company's assets and projected cash flows are.
Therefore, there can only be two reasons that management proposes a buyout: They either think they are getting a great deal and will make a lot of money, or they are incredibly stupid. If a stock is selling at $10, and "worth" $20, paying under $18 would fall into the former camp; paying north of $20 would fall into the latter camp.
It's not quite that simple, because there have been a number of management-led buyouts at prices, and with structures, that have led to bankruptcies. But I think the point is valid and clear -- particularly in a marketplace where hundreds of perfectly decent nontech companies are selling at 10 times earnings and 50% off their all-time highs and there are a variety of wacky Seagate-like valuation anomalies given the dot-com craze.
Back to the Deal
Management and Silver Lake Partners are buying Seagate's disk-drive operations for $2 billion in cash, which values them at about 30% of sales. For comparison's sake,
-- the erstwhile second banana in the industry -- sells at a depressed 40% of sales. I've seen published numbers that value the disk-drive operations of Seagate at close to $7 billion. Almost any way you cut it, $2 billion is a pickoff.
Management argued for the deal in a variety of ways. One of these was to claim that this structure was the only way in which to avoid a considerable tax hit for the sale or spinoff of its Veritas shareholders. But this is not necessarily true, as
recently accomplished a similar task through the creation of a new class of voting stock in
No doubt Veritas prefers the current deal: Not only does it get to buy its stake back from Seagate at a 15% discount to market in the proposed transaction, it also avoids any potential problems caused by a flood of stock hitting the market from another method.
The fact remains that Seagate shareholders would seem to be better off with this kind of scenario, which would let current shareholders make their own decisions on the Veritas tax hit and the appropriateness of its valuation. Moreover, they keep the upside on an improvement in the storage business, as well as retain the substantial cash holdings and other investments at Seagate.
In published press reports, Seagate's CEO
was quoted as saying he did not participate in the board vote in order to remove the conflict of interest, and that the company solicited other bids but received none better, and furthermore, if Seagate were worth more, "then why isn't the stock trading any higher?"
What's a Board of Directors to Do?
Ah, now there's the rub. Getting back to my original point: If the equity value of a company does not reflect the fair market value of the company's assets and cash flow, what should the attitude of the company's board and management be?
Should it be to carefully analyze current operations and investment opportunities to ensure that they are generating returns above the corporate cost of capital and eliminate those that don't?
Should it be to examine financial strategies to monetize noncore assets and/or investments to maximize their value? Should it be to repurchase shares aggressively, creating a more tame "public LBO" to ensure that shareholders participate in the closing of the value gap?
Should it be to improve financial disclosure to potential investors to help them understand the inherent values in the company? Or should they be opportunistic and try to capture the spread between the public value and the private value for themselves?
I am a firm believer in the law that says "this is America and you eat what you kill," and naturally I wish
called me a year ago and invited me to join Silver Lake as a partner and be on the right side of these deals. I also understand the frustration of many CEOs when the wackiness of the market in the short run implies that their core business seems to have a negative value, implying that every day they come to work, it hurts the value of their stock.
But a board of directors does not have the same mission as
. Carl Icahn is there for Carl and his related Icahns. The board's job is to ensure that all public shareholders receive fair value for their investment. That is clearly not the case here.
Management even alluded to the very strong possibility of taking Seagate public again, after the closing of this transaction, which further highlights what is wrong here. This is simply an attempt to arbitrage the difference between real assets and perceptions warped by valuations for technology and Internet companies.
This is another case of the near joke of market efficiency in the short and intermediate run. Veritas is clearly overvalued, while Seagate's stock is undervalued -- and management may be able to walk away with the prize, if there is not another bidder who is willing to step to the plate. The real issue is that management obviously believes that the present value of Seagate's business far exceeds $2 billion. These are not stupid people. Don't they have a fiduciary responsibility to demonstrate the values for everyone?
Jeffrey Bronchick is chief investment officer of Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Fund. At time of publication, neither Bronchick nor RCB held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at