Sealed Air

The Leveraged Recap Of Sealed Air Corp.

Prof. Ian Giddy, New York University

The Leveraged Recapitalization

Less than a year after Sealed Air embarked on a program to improve manufacturing efficiency and product quality, the company borrowed almost 90% of the market value of its common stock and paid it out as a special dividend to shareholders. Management purposefully and successfully used the leveraged recapitalization as a watershed event, creating 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. This decision provides a context in which to explore how financing decisions affect organizational structure, management decision making, and firm value. It gives one an 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.

In 1989 the company's stock price seemed depressed -- at best, it was going nowhere. Yet Sealed Air's business threw off a lot of cash. Prior to the recap the company had over $50 million in cash and short-term investments and Dermot Dunphy, CEO, expected cash on hand to more than double over the next year and a half. Bruce Cruickshank described the company's situation, stating "there were no good acquisitions and we had nothing to do with the cash. Just increasing the dividend over the years was admitting defeat. We didn't want to be a public utility."

One reason that Sealed Air's stock was "undervalued" was because the company was generating "free cash flow". Free cash flow in excess of that required to fund all the company's positive net present value investment opportunities tempts companies to waste money. Pete Funkhouser, Senior Vice President, described this problem at Sealed Air, "We didn't need to manufacture efficiently, we didn't need to worry about cash. At Sealed Air, capital tended to have limited value attached to it - cash was perceived as being free and abundant." For some companies, the most productive use of free cash flow is to distribute it to shareholderss and allow them to reinvest of spend it as they choose. The market applied a discount to Sealed Air's stock because manaagers could not make a believable promise to disgorge the cash. Paying out today's cash balance ($54 million) would not solve the problem. Borrowing and paying the proceeds to shareholders served to reinforce managements's promise not to retain future excess cash.

Sealed Air's management faced many alternative uses for the company's cash. Among them were launching a capital expenditure program, buying another company, increasing the regular dividend, or starting to manage a portfolio of securities. One could argue that the decision to recapitalize demonstrates a failure on the part of the top management team; they should have been able to find something productive to do with the money.

In fact, Dunphy felt strongly that his job was not