To understand why high finance has trounced high tech as a profit center for Seagate shareholders, let’s look at a proposed series of complicated transactions involving Seagate and a company called Veritas Software, in which Seagate owns about a one-third stake. If all goes as planned, Seagate will have made far more for its shareholders in less than two years of tax avoidance than in two decades of disk making. In the process Seagate is providing a big, fat bonus for selected top executives in an arrangement that has provoked more than 20 lawsuits.
Here’s the tale. A year ago Seagate traded its software business to Veritas in return for a big slug of Veritas stock. Veritas’s market price promptly took off for the moon, but Seagate’s remained in Earth orbit. Suddenly Seagate’s stock-market value was less than the value of its Veritas stake. Which means that the market, in its wisdom, was valuing Seagate’s disk-drive business, cash and other holdings at less than nothing.
Last year Seagate sold some Veritas shares to turn part of its windfall into cash. But that produced–yechh!–taxable capital gains. Distributing its remaining $13 billion (at Thursday’s closing price) Veritas stake as a dividend to Seagate holders or selling it would cost Seagate maybe $5 billion in capital-gains taxes. Stockholders would have to pay billions more in taxes on any dividend Seagate paid them, be it in cash or Veritas stock. What to do? With the cooperation of Veritas, Seagate came up with a brilliant ploy: a “corporate reorganization” that amounts to a sale. Seagate will sell its disk-drive business to a management-led leveraged buyout called Suez Acquisition for $2 billion in cash and liquidate its other holdings. Thus, Seagate’s only significant assets will be cash and Veritas shares. It will then be acquired by Veritas for Veritas stock with a soupcon of cash tossed in. Stock-for-stock swaps, of course, are tax-free until the recipients unload their shares.
Why would Veritas go to the trouble and expense? Easy. It will get 128.1 million of its shares by acquiring Seagate but will give Seagate holders only 109.3 million shares. Everyone wins except the tax man. Seagate saves $5 billion of corporate taxes. Its holders defer, possibly forever, taxes on $11 billion of Veritas stock they receive. Veritas retires $2 billion of stock without having to pay anything for it. Sweet. (For various reasons, Veritas will probably issue more than 109.3 million shares in return for Seagate’s excess cash. But the 109-for-128 swap is the guts of the deal.)
And it’s all perfectly legal. “This is a wonderful way for Seagate to liberate its Veritas holdings,” says Lehman Brothers tax expert Robert Willens. “Seagate comes out ahead and Veritas comes out ahead.” What’s even better, he adds, is that this deal fits comfortably into existing tax law, rather than pushing it, and would be OK even if proposed loophole-closing legislation becomes law.
In contrast to saving $5 billion of corporate taxes and billions more at the stockholder level, Seagate is getting a crummy $2 billion for its disk-drive business. Actually, even $2 billion overstates the real price, because Seagate is throwing in $775 million of cash and has apparently structured the deal to let Suez Acquisition save more than $800 million of income taxes over 12 years.
What’s more, the Seagate executives who are part of Suez Acquisition get a nice tax break themselves. They get to trade their Seagate stock options to Seagate as part of the purchase price, avoiding tax on an indicated $150 million to $250 million of profits. By contrast, Seagate’s other employees have to pay taxes on their option gains. There’s yet another tax gimmick. Seagate’s gain on the sale of the disk-drive business will be more than wiped out by the deductions it gets from employees exercising options.
Wall Street is carrying on about Suez Acquisition’s supposedly getting too good a deal on the disk-drive business. (Seagate wouldn’t talk, claiming its lips are sealed because it’s in Securities and Exchange Commission registration.) But watch for this deal to go through in some form. And watch for Suez to take New Seagate public shortly after the dust settles. And watch for tax pros to use this deal as yet another example of how fountain pens can make you more money than factories can.
