It’s a Wrap

Eight years after leveraging itself to the hilt, what could bubble wrap king Sealed Air do for an encore? Answer: Buy a company twice its size.
A CFO InterviewOctober 1, 1997

Imagine an acquisition that lifts a company’s market value by 10 percent the very day the Dow Jones Industrial Average skids 250 points. “A marriage made in heaven,” says Morgan Stanley analyst Mark Gulley, on news of the $4.9 billion merger between Sealed Air Corp. and the Cryovac packaging division of W.R. Grace & Co. He told the Wall Street Journal, “You get a highly regarded Sealed Air management combined with Grace’s worldwide product line.”

This from a company that in 1989 had elected to pay shareholders a whopping $40 dividend (90 percent of the going share price) on a then-outstanding 8.2 million shares (see “Maximum Debt,” CFO, May 1995). In the process, T.J. Dermot Dunphy, Sealed Air’s chairman and chief executive officer, and William V. Hickey, then CFO and now president and chief operating officer, upended the Bubble Wrap maker’s debt-equity structure. Sealed Air cranked its long-term debt up almost 20-fold, to $334 million, or nearly six times annual operating revenues.

Eight years after the recap, with debt whittled down to around $78 million (a mere 21 percent of capital), pressure was mounting for Sealed Air’s next act. Would it be an acquisition despite a climate of lofty asset prices? Another recap aimed at turbocharging returns with leverage? In one surprising swoop, Sealed Air did both. Using a Morris Trust format, it swallowed a company nearly twice its size and ended up in charge with a leveraged financial structure poised for global expansion.

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CFO’s New York bureau chief, S.L. Mintz, caught up with Hickey at Newark Airport, en route from Boston to London, a few hours before the quiet period mandated by the Securities and Exchange Commission descended. It was enough time, however, to glean an insider’s account of a transaction that might supply a blueprint for pure plays to follow.

When we left off more than two years ago, you advised us to “stay tuned.” Can you fill us in on events leading up to the announced merger with Cryovac?

Since we paid the special dividend, we proceeded for the next two years to tighten up and pay down the debt. In the meantime, we were able to make a couple of acquisitions in 1991 and 1995, both of which we did with additional borrowed money. Debt began to drop very quickly, so that at the end of 1996 we had $115 million outstanding. By the end of the first quarter [1997], it was down to about $100 million.

Institutional shareholders–analysts– said, “Well, Sealed Air, what are you going to do now?” We had obviously been thinking of this. We didn’t just start thinking at the end of 1996. This has been a process we’ve gone through on an ongoing basis. How do we continue to grow the company? How do we continue to add value? How do we manage it as a shareholder? We began to think of transactions. We considered another dividend. We considered a stock buyback.

So you considered another megadividend?

It did come up again, as recently as three or four months ago. We used shareholder meetings, Wall Street conferences, institutional analysts’ meetings to throw the question back at our institutional shareholders. What makes sense to you? What is the right thing to do? One particular Wall Street analyst, Mark Gulley of Morgan Stanley, said that the ’90s are different from the ’80s; shareholders are not as much interested in value as they are in growth. It was an impassioned plea that value was not the place you want to be in the ’90s, that’s not what shareholders are looking for. They aren’t looking for another deleveraging story. They are looking for top-line growth and expansion, a growth play as opposed to a value play.

We tested that [growth] concept on a number of people, all of whom suggested that it was clearly the preferred course of action. Absent that, however, we should do either a dividend or a stock buyback [because] clearly, Sealed Air should not remain underleveraged. We continued to look at acquisition opportunities as our first choice, while at the same time, we began to dust off plans for various other forms of recapitalization.

Much of the reason for your 1989 recap was a lack of acquisition opportunities at the right price. Now, eight years later, prices are up severalfold. Seems to me that a recap would enjoy more appeal than an acquisition.

This is a rather unusual, unique opportunity. This is a world-class franchise that we have known for years, and they have known us for years. The combination has been speculated upon by numerous people.

So there is not a philosophical or climatic shift with respect to the business, finance, or mergers and acquisitions. Your philosophy is the same as it was in 1989.

Absolutely. No change.

The motivation for another dividend is still present, absent a better way to invest the money?

Right. And in this case, when this came around even at the multiples in today’s stock market, recognizing we’re also at this multiple, the analysis clearly indicated that the recapitalization wasn’t as good.

What did that analysis entail?

What we looked at is the company’s growth rate in cash flow from a base period going forward, and what that growth rate implied in terms of multiples. Clearly, a faster growth rate would command a higher multiple in the marketplace. The recapitalization, to use a description we’ve used among ourselves, had a less steep slope.

You could see over time if you plotted it out, that an acquisition was going to produce…

This would produce a longer, higher growth rate than a recap transaction would.

That explains why you wanted the deal to happen. What about Grace?

Part of it is changes in management at Grace over the years. You really need to give credit to Al Costello, the current CEO of Grace, who basically saw the value in this business as it would be outside of Grace.

He’s taking a rare step. After this transaction, he’ll be running a smaller company.

That’s right. It’s a very courageous step. I personally believe he’s made the right decision for Grace shareholders, and that’s been reflected in the value of that company.

They could have spun off the packaging division separately.

Spinning it off separately was one possibility. The question is, without Sealed Air’s reputation and track record and management credibility, would they have gotten Sealed Air’s multiple?

Then your stock price jumped because the stock market assigned your multiple to the Cryovac business.

Which is what we all really thought would happen. It’s a premier business, a superb franchise that deserves a multiple like Sealed Air’s multiple. It has a lot of the characteristics of the Sealed Air business, but it’s been hidden in a multi-industry conglomerate, as opposed to a focused play. Sealed Air and Cryovac have become a pure play.

Then it’s not a question of restructuring or throwing out layers of management or reducing costs, just primarily the inevitable synergy of putting a good business together with good management.

This is not a slash-and-burn merger. There’s very little in the way of cost cutting. There are always obvious overlaps, administrative costs. But by and large, it’s a growth merger. We have a food-packaging division that’s about 12 percent of our sales. The rest is industrial packaging. Cryovac’s almost the flipside.

What about the finance department?

The finance department remains part of Grace. As an ongoing public company, it will continue to have its CFO and controller and its treasury organization. We are essentially taking an operating division.

Once you decided that this merger made sense, how long did it take to arrange?

Just a couple of months, mostly to ensure that the companies could be merged on a tax-free basis.

Were you waiting for the outcome of the recent tax proposals?

We thought we were okay, because one of the interesting aspects of this combination is that Sealed Air is the smaller company. That allows the Grace shareholders [who exchange Grace shares for Sealed Air common and convertible shares] to retain greater than a 50 percent ownership, thereby preserving the Morris Trust structure. The current legislation seems to prohibit a Morris Trust if shareholders of the larger company end up with less than 50 percent. So this is an ideal combination. If Sealed Air were a larger company, we couldn’t do this deal this way.

Isn’t the issue semantic? After the deal, Grace shareholders will become Sealed Air shareholders, not Grace shareholders with a residual interest in Sealed Air?

This is a technical issue. The tax laws apparently require the current Grace shareholders to own more than 50 percent of Sealed Air after the transaction in order to maintain its tax-free nature.

It’s early, of course, to draw final conclusions. But it is safe to say that few deals get such an enthusiastic response.

It is interesting that in most transactions the buyer’s shares go down and the seller’s shares go up. In this case, both went up.

Against the backdrop of a 250-point one-day plunge by the Dow Jones Industrial Average, you might say, “Terrific, the market went down, but we went up.” Or are you tempted to wonder how Sealed Air stock would have performed on an ordinary day in the market?

I think it’s as one of the Wall Street analysts said–this is a marriage made in heaven.

Matches made in heaven do not normally depend on favorable tax rulings. Did you compare a Morris Trust with taxable transactions, in search of the steeper slope?

No, because of a couple of restraints. One was to try to make it tax free. The other was to use as much [Sealed Air] equity as possible to take advantage of that currency.

Who gets credit for dreaming up the Morris Trust?

Grace had already done one a couple of years ago, with its medical business. They did a transaction with National Medical Care, so our deal was really modeled after that.

What about pricing?

We had a fairly good sample in comparable packaging companies, which included Sealed Air.

To the extent pricing is favorable, Grace shareholders participate.

They’ll have the choice.

How did this affect negotiations?

It was interesting when we were talking about the purchase transaction with the people at Grace. They said Grace shareholders end up absorbing 63 percent of whatever price Sealed Air pays, so that brought a little balance to the negotiation. Everyone wanted a fair deal because too high a price would result in Sealed Air not achieving its shareholder returns, thereby diminishing the value of the 63 percent that the Grace shareholders own. So it had almost a built-in balance.

Why the mix of common and convertible stock?

The common and convertible mix enabled us to issue common stock at a premium and thus reduce the number of new shares. The preferred is convertible into common at $56.525 a share. So, in effect, we were issuing common at $56 a share instead of $48 [the market value just before the deal was announced], with the goal being less dilution.

When the stock price nudged $53 a share soon after the announcement, it looked as if the market wanted to attach the higher value to the stock.

That wasn’t intended to be telegraphed. That wasn’t the message. Actually, the conversion price was determined by the investment bankers.

The price tag also includes a $1.2 billion contribution to Grace Specialty Chemicals. How will that be financed?

We haven’t structured that yet. It will be some combination of bank debt and public debt. Could be $600 million of each. We do not need to go out a long time. Whether it’s 7 years or 10 years, that’s our thinking now.

Acquiring Cryovac has killed a few birds with one stone. How would you summarize what it has accomplished?

It met the next thing we needed to do in terms of the company’s capital structure.

And what will the capital structure look like?

Actually, we will not be highly leveraged. We’ll have $2 billion in equity and around $1.3 billion of debt. After the recap in 1989, we were over 100 percent debt.

Sounds like a piece of cake this time.