Session 8 Seagate case - This case study highlights the issues involved in considering whether an entrepreneurial PDF

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This case study highlights the issues involved in considering whether an entrepreneurial firm presents an opportunity for a management buyout. The case involves examination of issues relating to management, the market, the product, investment needs, and financial issues. Also, the case provides an...

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Seagate Technology Summary This case study highlights the issues involved in considering whether an entrepreneurial firm presents an opportunity for a management buyout. The case involves examination of issues relating to management, the market, the product, investment needs, and financial issues. Also, the case provides an opportunity to examine the scope for management buyouts beyond traditional areas of firms in mature sectors with stable cash flows and low investment needs. Introduction Seagate Technology Inc. designs, manufactures, and markets products for storage, retrieval, and management of data on computer and data communications. Their products include disc drives and disc drive components, tape drives, and software. Seagate is the world’s largest manufacturer of disc drives and disc drive components, magnetic discs and read-write heads, an innovator in tape drives, and a leading developer of Business Intelligence software. The firm’s major customers include original equipment manufacturers, distributors, resellers, dealers, systems integrators and retailers. Seagate is based in Scotts Valley, California, but has operations throughout North America, Europe, and Asia, and employs more than 87,000 people worldwide. Seagate’s storage products include a comprehensive line of disc drives for the desktop personal computer (PC) market, higher performance PC and workstation drives, and higher-capacity drives for the storage and performance-intensive network server, disc array, and audio-visual markets. Their Internet Solutions Group targets emerging markets and applications that are storage-intensive, specifically in the areas of consumer electronics, commercial and services opportunities related to web-based applications. The Removable Storage Solutions group offers a broad line of tape drives for backup on networks, multi-user systems, workstations, desktops and portable PCs. Seagate Software is a majority owned and consolidated subsidiary of Seagate Technology, which develops and markets software products and provides related services enabling users to store, access, and manage enterprise information. The company has pursued a strategy of vertical integration with regard to its core product line of rigid disc drives and related components. Over the years, they have broadened their strategy to additionally address the markets for storage, retrieval, and management of data. In order to pursue this broad strategy, the company has acquired, invested in, and formed strategic alliances with complementary businesses. Seagate’s approach includes acquiring companies that posses technology and development personnel which provide long-term growth potential to their business. Seagate Technology was founded as a disc drive manufacturer in 1979 by industry legends Al Shugart, Tom Mitchell, and Finis Conner. In 1980, they introduced the industry’s first 5.25-inch disc drive, which was “instrumental in turning the original IBM PC into a serious business tool, and drove the company to a dominating presence in the early PC industry” (Silicon Valley.com, 3/00). Founder Al Shugart was instrumental in the invention of the disc drive, and pioneered the development of the floppy drive during his 18 years with IBM, prior to forming his

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own company. Shugart and his Seagate associates are credited with having led the way in the PC revolution. Seagate floated on the New York Stock Exchange in 1981. From its beginnings in 1979, Seagate has grown both organically and through a number of acquisitions and investments. At their peak in 1997, Seagate controlled an estimated 50% of the market for disc drives in PCs, with more than 100,000 employees, and sales that approached $9 billion a year. Seagate, however, has demonstrated a critical vulnerability to the cyclical trends that plague the high-tech industry. T. Quinlan (2000) asserted that: “Although Seagate officials had a tendency to announce that they had broken the cycle at the end of every downturn- by acquiring software companies or other disc drive companies as the opportunity presented itself- it was a pattern that would constantly afflict the company”. Seagate had a breakthrough year in 1984, with sales of $344 million and profits of $42 million. By the following year, sales had fallen to $215 million with profits of only $1 million. Seagate suffered from the cyclical nature of the industry again in the late 1990s when revenues fell from $8.9 billion in 1997 to $6.8 billion in 1998, with profits declining from $658 million to a $530 million loss in 1998. A series of layoffs associated with the latest downturn has left the company with an estimated 60,000 employees, and ultimately resulted in Shugart being forced from the company he created and led for nearly 20 years. In addition to the dangers of operating in a cyclical industry, Seagate has struggled as a result of intensely competitive market conditions and pressure from PC companies to make bigger disc drives at lower prices. While their drives have increased dramatically in size, their prices have fallen, leading to a declining profit margin. Management Team Seagate Technology was founded in 1979 by Alan F. Shugart, David (Tom) Mitchell, and Finis F. Conner. Al Shugart joined IBM in 1951, the day following graduation from university. In 1969, he left IBM to work for Memorex Corp., taking with him approximately 200 engineers. A few years later when Memorex was experiencing troubles, Shugart, along with several loyal followers, launched Shugart Associates, which was responsible for pioneering the floppy drive. Finis Connor, who had started at IBM as Shugart’s gofer, was among the group. In 1974, the company ran into problems and Shugart’s venture backers fired him. Four years later, Connor approached Shugart with the idea of developing small hard drives for PCs. With $1.5 million in start up capital, Shugart, Connor and four associates formed Seagate. With the enormous surge in the PC market, Seagate prospered and reported revenues of $344 million by 1984. The following year, amid brutal price wars, the tides were turning. While Shugart insisted on making disc drives from scratch, Connor disagreed, arguing that buying parts involved less risk. This conflict represented an apparent pervasive divergence in corporate strategy between the two founders, and Connor left Seagate to launch a rival disc drive company, Connor Peripherals. Compaq Computer Corp. backed connor Peripherals, and sales rocketed to $113 million in the first year. Connor’s company was so successful that in the late 1980s he considered buying 2

Seagate. Connor’s success, however, was short-lived, and, in the end, Shugart’s strategy of vertical integration was vindicated. In 1993, the demand for PCs had exploded, and key components became scarce. Companies like Connor’s that followed an outsourcing strategy, suffered and every drive maker except Seagate lost money. Seagate acquired rival Connor Peripherals in 1996, boosting their market share to 33% of the of the then $25 billion industry. Following Connor’s departure, Seagate was run by Shugart, co-founder Mitchell, and Douglas Mahon. Shugart, already a famous figure in the industry, was the company’s public face, the ‘emblem on the car’, in the words of a former executive. Shugart is said to have achieved success the old-fashioned way, defying the era’s common management wisdom. A true entrepreneur, Shugart apparently enjoys dabbling in other businesses. He has owned a gourmet restaurant, an air charter service, and funds a publisher of quirky books. When Shugart launched Seagate he was in his 50s, ancient by Silicon Valley standards. He is said to have come to work in a short-sleeved polyester shirt, without a tie, and answered his own telephone calls. In a recent interview, he described himself as a ‘street guy’ and a ‘regular guy’ and not a corporate executive. He even tried to run his dog Ernest for congress, an antic that raised $3,000 and involved buttons, a campaign committee, and press releases. Despite his unique management style, Shugart’s presence in the disc drive business has been likened to Bill Gates’ in software. Shugart is said to have been popular with his employees, winning tremendous loyalty. This loyalty got him in trouble in 1994 when he was sued by his former employer, IBM, for hiring away the engineer who was heading up its development of magneto-resistive heads. With charismatic Shugart at the helm, Mitchell was in charge of operations, and Mahon was in charge of product design and technology. Mitchell, an ex-marine, is said to have run the company with an iron grip, driving the business forward with what he used to boast was ‘management by intimidation’. Described by one analyst as ‘the Darth Vader of the industry’, Mitchell is said to have made people work through the Christmas and Thanksgiving holidays. He had a reputation for being a demanding, driven perfectionist, and during his leadership as president and chief operating officer Seagate had an extraordinarily high turnover rate. Many of the employees who stayed on, however, became very rich, and Seagate became the world’s largest disc drive manufacturer. Where Shugart has been described as rumpled, affable, and blunt, Mitchell has been portrayed as polished, charismatic and brutal. As a result of these differing management styles, and after a failed bid to become the chief executive officer (CEO) in 1991, Mitchell left the Seagate and went on to join forces with Connor, as CEO, at Connor Peripherals. Shugart is credited with transforming Seagate into a more mature and stable company after taking over the day-to-day operations following Mitchell’s departure. He made a concerted effort to distance himself from the management style imposed by Mitchell, improving the company’s reputation with employees. According to Phil Devin, chief analyst of the industry for Dataquest Inc., Shugart: “runs the company in a more conservative down-to-earth business manner rather than engaging in egotistical bashes to become the market leader” (Levander, 1995).

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Shugart demanded hard work, but also recognized the restorative value of having a good time, and has been famous for holding impromptu staff meetings at local bars. Whereas Mitchell was considered a demanding tactician, Shugart is described as a strategist and a delegater who takes pride in freeing people up to do their jobs. While being technically astute, colleagues have credited Shugart’s success to his managerial style, and he is said to balance his no-nonsense style with ‘a huge appetite for fun’. Today, however, Seagate still possesses its high-pressure reputation and company nicknames include ‘Slavegate’ and ‘Stressgate’. In 1993, Stephen J. Luczo, former investment banker from Bear, Stearns & Co., joined Seagate as Senior Vice President of Corporate Development. As the chief planner of Seagate’s expansion into software, Luczo was appointed as chairman and chief operating officer in September 1997. At the time of his appointment, Luczo was viewed as the executive most likely to succeed Shugart, despite Wall Street’s criticism of his apparent lack of experience in manufacturing operations. Less than a year later, in July of 1998, the company’s board of directors fired Al Shugart, as he apparently refused to acquiesce to a quiet succession plan. Company officials justified Shugart’s forced resignation, at age 67, as the latest effort by the company to survive in an increasingly competitive hard drive industry. Shugart was fired because it was deemed time to accelerate the pace of change in the company. Stephen Luczo was promoted to CEO and appointed to the board of directors following Shugart’s dismissal. Shugart maintained that the company failed to give him a reasonable explanation for his ouster, other than wanting changes in leadership. Despite being in his late 60s at the time of his ousting, Shugart claims no plans for retirement and reports that he has received requests to join company boards and review business plans. Firm Performance The dramatic downturn in the high-tech industry in the late 1990s resulted in slim margins and intense competition, decimating profits for both Seagate and its competitors. Seagate, however, was hit particularly hard. Revenues declined from $8.9 billion in 1997 to $6.8 billion in 1998, with profits of $658 million in 1997 declining to a record loss of $530 million in 1998. The company blamed poor results on the continuing decline in the average unit sales price of their products as a result of intensely competitive market conditions, coupled with a lower level of unit shipments reflecting continuing weakness in demand for disc drive products. In addition, Shugart’s strategy of vertical integration was partially blamed for the losses. In their annual report, company officials site the strategy as incurring a high level of fixed costs, which requires a high volume of production and sales to be successful. Consequently, during periods of decreased production, as witnessed in 1998, the high fixed costs associated with vertical integration apparently had an adverse effect on operating results and financial conditions. This strategy has also been blamed for delays in the company’s ability to introduce new products. When Luczo became chief operating officer in 1997, one of his boldest moves was to challenge Shugart’s strategy of backwards integration, arguing that the policy was out of date. Luczo contended that outsourcing would be cheaper and would allow the company to take advantage of new technologies and products developed elsewhere. Luczo also worked hard to rationalize costs, which involved cutting more than 10,000 jobs and consolidating the company’s design centres from five to three. 4

Arguably, as a result of Luczo’s take-over of the daily operations of Seagate, the financial results for 1999 were slightly improved. Revenues for 1999 were pretty flat compared to 1998, but profits increased to $1.2 billion. The recovery in profits, however, came only minimally from operations, and was predominantly a result of a gain related to the selling off of part of their software division. In June 1999 Veritas, which makes programmes to protect computer data, bought the software unit of Seagate, paying for it with $2.7 billion of Veritas shares. Subsequently, Veritas shares gained enormously in value, such that by March 2000 Seagate’s stake had ballooned to $21.7 billion. Seagate’s stake in Veritas, a third of the company, became worth more than Seagate itself. The problem for Seagate was that none of their investment in Veritas was reflected in their own market capitalisation, which stood at $15 billion. During the period from January 1999 to January 2000, the market price of Veritas shares rose 800%, while the market price of Seagate common shares did not significantly increase. Figure 1

Comparison of Daily Share Prices for Seagate and Veritas

As Veritas shares soared, Seagate needed to find a way to let its own shareholders benefit from the wealth. If the Veritas shares were distributed to Seagate’s shareholders, the transaction would incur double taxation, once for the corporation in realising its gain, and a second time for individual shareholders. With corporate taxation rates between 36% and 41%, the effect would be significant. Although the disc drive industry, having suffered through years of price competition and slim margins, has shown signs of recovery, it continues to lag the enormous stock market success of other high-tech sectors. Like other public manufacturers of computer components, Seagate’s share price has been highly volatile, suffering if investors’ expectations were not met. Although Seagate’s share price rose 60% in the three years prior to the buy-out agreement, their shares have

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lagged significantly relative to the NASDAQ Composite. Figure 2 shows Seagate’s change in share price relative to that of the NASDAQ Composite. Figure 2

Seagate Share Price Compared to the NASDAQ Composite

Seagate’s performance has lagged even more significantly over the last three years when compared to its industry (Dow Jones Computer Index, CPR). Figure 3 shows share price fluctuations for Seagate relative to its industry. A table of ratio comparisons between Seagate, the computer industry, the technology sector, and the S&P 500, is presented in Appendices 1 and 2, showing that Seagate has under performed both its industry and sector in many areas. Figure 3

Seagate’s Performance Relative to the Computer Index

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According to McNamee (Silver Lake Partners, Venture Capital Firm): “The public market has not been patient with the storage industry, and being private will allow Seagate to make investments in product development to be more successful than it was in the past decade”. Seagate CEO, Luczo, claims the motivation for a buy-out transaction (LBO) arose because the market undervalued Seagate’s underlying business, such that shares were trading at a substantial discount relative to the value of the company’s assets. Seagate trades on the NYSE at just 18 times earnings, compared to Cisco Systems Inc., whose technology is seen as more central to the Internet, which trades at 205 times earnings. Figure 4 shows changes in Seagate’s daily share price, relative to Cisco Systems. Figure 4

Changes in Share Prices for Seagate and Cisco Systems

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Appendix 1 Annual Balance Sheet ANNUAL BALANCE SHEET In Millions of U.S. Dollars (except for per share items)

As of 06/30/00

As of 07/02/99

As of 07/03/98

As of 06/27/97

As of 06/28/96

875.0

396.0

666.0

1,047.3

503.8

1,140.0

1,227.0

1,161.0

1,236.3

670.3

2,015.0

1,623.0

1,827.0

2,283.6

1,174.1

678.0

872.0

799.0

1,040.8

1,066.5

–

–

–

–

–

678.0 430.0 – 386.0 3,509.0

872.0 451.0 – 366.0 3,312.0

799.0 508.0 – 481.0 3,615.0

1,040.8 808.3 – 419.6 4,552.3

1,066.5 790.8 – 367.9 3,399.3

3,754.0

3,533.0

3,242.0

3,058.4

2,404.5

(2,146.0)

(1,846.0)

(1,573.0)

(1,271.8)

(1,004.7)

Property/ Plant/ Equipment, Net Goodwill, Net Intangibles, Net Long Term Investments Other Long Term Assets Total Assets

1,608.0 353.0 – 1,122.0 575.0 7,167.0

1,687.0 144.0 – 1,745.0 184.0 7,072.0

1,669.0 169.0 – 0.0 192.0 5,645.0

1,786.6 199.1 – 0.0 184.9 6,722.9

1,399.9 274.0 – 0.0 166.4 5,239.6

Accounts Payable Accrued Expenses Notes Payable/ Short Term Debt Current Port. LT Debt/ Capital Leases Other Current Liabilities Total Current Liabilities

707.0 689.0 – 1.0 81.0 1,478.0

714.0 782.0 – 1.0 43.0 1,540.0

577.0 777.0 – 1.0 20.0 1,375.0

863.1 902.8 0.0 1.1 69.3 1,836.4

715.4 670.9 0.0 2.4 49.4 1,438.1

703.0

703.0

704.0

701.9

798.3

–

–

–

0.0

0.0

703.0

703.0

704.0

701.9

798.3

Cash & Equivalents

Short Term Investments Cash and Short Term Investments Trade Accounts Receivable, Net

Other Receivables Total Receivables, Net Total Inventory Prepaid Expenses Other Current Assets Total Current Assets

Property/ Plant/ Equipment - Gross

Accumulated Depreciation

Long Term Debt

Capital Lease Obligations

Total Long Term Debt

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Total Debt

704.0

704.0

705.0

703.1

800.7

Deferred Incom...