Sealed Air had a long tradition of placing focus on marketing rather than manufacturing because there were relatively fewer competitors. Nevertheless, in the 1980s, the company could no longer sustain profitability with its market-oriented strategy. The number of competitors in the market finally increased, and patents became important in business success. Sealed Air retaliated by resorting to the WCM- World Class Manufacturing program, which was primarily aimed at upholding excellence in manufacturing. The immediate implications of this change of strategy were the increase in the firm’s cash and debt capacity. In 1989, Sealed Air’s stock price was seemingly undervalued, and the company had just begun experiencing cash management issues. By this time, the company had $50 million in cash as well as a short-term investment. The amount was expected to increase twofold by the next annual period. Excess cash flows meant that sealed air had free funds that were not allocated to investments. In addition, the company did not have valuable investments and opportunities, and competitors were marketing cheap substitutes of the firm’s products by innovating their goods around Sealed Air’s patents. Therefore, the management welcomed the idea of leveraging recapitalization. The firm not only wanted to change the competitive environment but also retain its authority in the market.
The leveraged recapitalization was an attractive idea because it would increase stakes for worker ownership, bring a new pool of investors, and result in substantial dividend payouts to stakeholders. Intrinsically, leveraged capitalization occurs when a firm turns to the debt market to issue bonds. While resorting to debt markets seems counterproductive, a firm’s decision to pay debts, acquire stock, and recompense investors may be inspired by several microeconomic drivers such as low-interest rates on borrowed capital. At the micro-level, a business may turn to debt so as to balance leverage and enhance operational efficiency such as in the current case. Sealed Air used the proceeds it gained from bonds to distribute equity to investors and buy back shares. The leveraged recapitalization was particularly beneficial to stakeholders as it resulted in higher value and magnified operating returns. The initiative also enhanced near term earnings and growth, improved future cash flows for development and re-investment, and created new equity based on the need to improve performance. By engaging in leveraged recapitalization, Sealed Air increased its financial leverage and reduced its publicly-traded equity. The increase in debt instead of equity helped the company to avoid the dilution of ownership as well as the extended effect of shareholders on the operations of the company.
On the other hand, leveraged recapitalization hurt institutional investors, pension funds managers, and money managers. Institutional investors were compelled to sell stock before the prior dividend date in order to hold minimal level of market capital by investment. Pension owners were forced to sell ownership because of requirements for owning dividend-bearing resources. After the recapitalization period, investor responses were diverse in a firm that was now considered to have a negative net worth. Two more potential disadvantages of leveraged recapitalization have to do with selling to private equity firms and renouncement of control. Firstly, private equity firms do not pay high prices compared to strategic buyers because they are financial buyers and do not enjoy the opportunity of exploiting operating and financial synergies. Secondly, the owners relinquish the control of the company.
Indeed, companies have used leveraged recapitalization to create “optimal” debt capacity to ward off hostile takeovers in the past. The “optimal” debt ratio represents a financially leveraged debt ratio, which is achieved by adding debt and eliminating debt capacity and free cash. The case of Sealed Air showed that a company is independent of the debt ratio that is used to finance its ventures. In line with trade-off theory a firm chooses the amount of equity or debt to finance so as to balance costs and benefits. Even so, not all recapitalization processes are beneficial and not all companies will always reap from recapitalization. This is because firms have varying optimal debt levels based on their market sector. Additionally, markets differ by size, competition, and development. Companies that rely on innovation and knowledge usually perceive their market value in terms of potential future growth. In any case, firms need to uphold a low level of debt and retain cash to avoid the chance of bankruptcy. A case in point, a firm operating in the financial industry views money as its commodity. The profitability of operations in the financial sector arises out of high leverage. Hence, companies operating in the financial industry will encounter a unique set of market conditions that differ from that of another industry. Development stages also exert different effects on optimal leverage levels. For instance, young firms in booming industries rely on less debt with high future volatility. However, companies with large amounts of assets in stable markets depend on more debt, which requires greater capital investment in anticipation of future growth. In the case of Sealed Air, leveraged recapitalization increased stakes for worker ownership, brought a new pool of investors, and resulted in huge dividend payouts to stakeholders. A company that would benefit from leveraged recapitalization today is Walgreens Boots Alliance because of its high debt capacity.
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