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The complex, $20 billion buyout of Seagate Technology last week produced one clear winner, Veritas Software, and another likely one, the investor group led by Silver Lake Partners and Seagate management that is purchasing Seagate's disc-drive business for $2 billion. Seagate holders may not fare so well because their investment now hinges on Veritas' volatile and high-priced stock.

Seagate, as Barron's has noted on several occasions, held a treasure-trove of assets that wasn't fully reflected in the market. Seagate's most valuable asset is its one-third stake in Veritas, some 128 million shares, which recently were worth $20 billion, more than Seagate's market value of $13 billion. Seagate didn't get much credit for its Veritas stock because its industry-leading disc-drive business was hurt by fierce competition, and because investors wondered if Seagate would unlock the Veritas stake.

Seagate moved to rectify that situation last week with its deal with Veritas. The terms of the transaction call for Veritas to take Seagate's 128 million Veritas shares and give back to Seagate holders an estimated 116 million shares on a tax-free basis, or about 0.47 of a Veritas share for each Seagate share. Seagate's disc-drive business will be sold to Silver Lake Partners for $2 billion. Reflecting that sale, Seagate holders will get $5 a share in cash. There are about 220 million Seagate shares outstanding.

Veritas wins because in return for accommodating the transaction, it gets to retire about 12 million of its shares, worth $1.5 billion, and receive about $1 billion in cash and securities on Seagate's balance sheet. Veritas held the upper hand in the negotiations with Seagate because only Veritas could enable Seagate to monetize its Veritas shares on a tax-free basis. The buyout group, which includes management, is picking up Seagate's disc-drive business for about 30% of revenues, while a far weaker disc-drive outfit, Western Digital, is valued at $1 billion, or 40% of sales. Seagate said the Silver Lake bid was the best it received and that it's open to additional offers. Given the sky-high valuations of tech stocks, it's amazing that the highest bid for an industry leader like Seagate is just $2 billion. The betting on Wall Street is that Seagate comes public within two years at a multiple of a $2 billion valuation.

The entire deal, however, could be in jeopardy if Veritas' stock, which fell 31 1/2 to 131 last week, remains under pressure. Seagate now is trading as a proxy for Veritas, which fetches 250 times projected 2000 profits. Seagate dropped 9 1/2 to 61 1/2 last week after hitting a high of 76 following announcement of the deal. Seagate holders are entitled to 0.47 of a Veritas share, worth $61.50, plus $5 in cash.

Before the deal last week, Seagate was supported by its disc-drive business, a cash hoard of over $1 billion, the Veritas stake and interests in other tech companies. Institutional holders, who might have been inclined to support the deal because Seagate's stock has doubled since the fall, may sour on it if Veritas keeps dropping. If Veritas drops to 100, which would still value the software company at 200 times earnings, Seagate holders would be staring at a package worth just $52 a share. In that case, many investors may vote against the deal and tell Seagate to keep its current structure.

Bob Willens, the tax expert at Lehman Brothers, thinks Seagate should explore a transaction with Veritas patterned on deals that allowed IMS Health to monetize its minority stake in Gartner Group on a tax-free basis, which was also done by Harcourt General involving its stake in Neiman-Marcus. Willens believes there's nothing in the tax code to prevent Seagate from swapping its Veritas stock for a new class of Veritas stock with 80% voting rights, which would allow Seagate to distribute its Veritas stock to holders on a tax-free basis. Such a deal would require Veritas' cooperation.

Under this scenario, Seagate would still be left with its disc-drive business and other assets while giving its holders the full value of Seagate's interest in Veritas.


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