Sealed Air, a highly profitable company with minimal financial issues, decided to undertake a leveraged rationalization in order to “strengthen and motivate the organization. ” The management of Sealed Air was “unable to identify profitable acquisitions or expansion projects” and simply “Increasing the dividend… [would be] admitting defeat. Starting with the World Class Manufacturing program to Improve Sealed Air’s manufacturing process, Sealed Alarm established new priorities, such as using cash flow from operations as a major factor in managers’ bonuses instead of earnings per share, and Sealed Air put more emphasis on employee stock ownership after the rationalization. We believe that Sealed Air made a good choice to leverage themselves to the extent that they did, and that decision benefited multiple parties.
Management believed that they were not as well suited to invest the $54 million in Sealed Air’s cash as their investors would be able to, thereby making those investors happy with the company’s decisions. Any shareholders that kept their shares following the rationalization did not lose equity In Sealed Air, which could eave happened If Sealed Air decided to Issue more shares. The company Itself was able to stay Independent without any need for an anta-takeover device. In order to determine how much value was created from Sealed Air’s decision to leverage Itself, we had to figure out the present value of the Interest tax shield.
For the senior secured bank credit agreement of $136. 7 million, we reduced the principal by the given repayments from 1991 to 1996 and each year calculated the interest due by multiplying the 11. 5% by the beginning balance at the start of each year. Each interest amount for those years was multiplied by the corporate tax rate (34% for 1991 and 1992 and 35% thereafter) in order to determine the present value of the tax shield, and the NP of $15,904,368 was determined based on those individual year values. For the subordinated bridge notes, the $170 million value was multiplied by the 12. 25% Interest rate to determine the Interest due. We multiplied this by a constant 35% corporate tax rate to determine the Interest tax shield. Using a formula to determine the full tax shield over the 10 years of the bridge notes, this present alee was found to be $41 Adding the NP and the bridge notes UP resulted in a $57,283,921 total tax shield, which represents the value that Sealed Air gained by the leveraged rationalization By creating value in terms of a tax shield, Sealed Air Corporation’s decision to pursue this leveraging up plan coincided with World Class Manufacturing.
The purpose of the WAC program was to revivalist the culture and operations of the company. In order to execute this program, however, the company had to change directions and become much more disciplined and organized in their operations. Once they were operating efficiently, they then had a structure in place that served as the foundation for the financial discipline that was then needed to take on a large amount of debt. Dormer Dungy, the CEO of Sealed Air, believed It was necessary to change the company’s prolepses and Incentive structure following the recap.
Dungy felt that management needed to place a greater emphasis on the Importance of generating cash flow. Prior to the recap, their Incentive structure was based on earnings-per-share, which takes into account non;cash accounting cash flow from operations. Additionally, Sealed Air focused on meeting inventory, receivables, and working capital goals that required management to be more aware of cash that was tied up in these balance sheet items. Dungy also placed a strong emphasis on employee stock ownership.
He felt that this sort of profit sharing would greater align the interests of shareholders and employees, and effectively improve the overall performance of the company. After the recap, many institutional investors had sold their holdings, and were replaced by “cash flow’ investors. On one hand, the institutional investors were more conservative. They aimed at investing in companies with consistent growth, a “solid” financial situation, and limited downside risk. On the other hand, the one-time special dividend eliminated pension funds that required themselves to hold dividend paying stocks.
Moreover, other institutional investors who sold their shares were negative toward leverage and deficit net worth. The managers of Sealed Air should be concerned more about this situation, and focus on cash flow projections. The important new shareholders for Sealed Air became speculative wealthy private investors who were looking for significant gains n profitability. This leveraged rationalization plan required management to curb their capital expenditures per year.
This situation could make it hard for a firm to stay competitive in the market but in the case of Sealed Air, the constraint imposed on capital expenditures under the bank lending agreement was good for the company, although it was difficult to achieve. Capital expenditures were restricted to a set amount from 1990 to 1995, which forced the Sealed Air to make wiser decisions to reduce capital expenditures and restructure the formal capital budgeting process. In this way, the company would generate more free cash flows, which would benefit the leveraged rationalization to some extent.
We think the managers would be able to renegotiate the covenant successfully. By the end of 1989, the leveraged recap proved to be successful, putting the company a year ahead of the principal payments required by the banks. The managers could renegotiate the covenant by identifying the success of the rationalization with stronger balance sheets. Leverage rationalization is a risky business venture for any company. When evaluating several options for the use of Sealed Air Corporation’s cash, management did not want to sit on their $54 million.
Rather, they wanted to keep company performance at a maximum. In order to do this, management decided to leverage up the company by borrowing money and paying out dividends to their shareholders. Management was confident Sealed Air’s cash flows would stay constant for the foreseeable future, which is necessary for leveraged rationalization to work. Furthermore, by leveraging the company, operational improvements were made by holding management responsible for increasing the corporation’s cash flows.
The use of leverage rationalization to change the organizational structure of the company also coincided with management’s implementation of World Class Manufacturing. Although leveraged rationalization worked out well for Sealed Air Corporation, it would not be good for all companies to do. A company who participates in leveraged rationalization has to be able to maintain or increase their cash flows for the life of their debt repayment. If a company is not able to hold a steady cash flow, they will have a hard time maintaining the interest payments on their loans.
A company who this procedure. A company whose cash flows can change as the market moves would not be well suited for this capital structure. In addition, a corporation must have a strong management core in order to maintain operational efficiency thus improving future cash flows for the company. If management shirks even a little bit, a corporation may be unable to lean out their operations as necessary. Finally, a company that needs to invest in capital expenditures in order to continue their operations would not be suited well for a leveraged rationalization plan. As seen by
Sealed Air Corporation’s binding debt covenants, Sealed Air was only allowed to spend a certain amount per year on capital expenditures. From analyzing this case study, as well as further research on Sealed Air Corporation, it can be seen that a leveraged rationalization plan worked out well for Sealed Air. Sealed Air had all of the necessary requirements in order to make a plan like this successful. The company created value for the corporation as a whole, as well as their shareholders. Management was able to show that the corporation’s shares were undervalued and improved investors’ perception of the company in the market.
