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A Deal With Taxing Consequences
Seagate's pacts with Veritas show how tax avoidance can save lots more for
shareholders than manufacturing can make for them
Newsweek, June 5, 2000
Seagate technology has been making computer-disk drives for 20 years and has become the biggest
player in a fast-changing, ultracompetitive business. A notable accomplishment. But instead of
being a story about American technological and manufacturing prowess, Seagate has become quite
a different story: how a company can earn more money by shuffling papers than by making
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
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
Sloan is NEWSWEEK's Wall Street editor. His e-mail address is firstname.lastname@example.org.
© 2000 Newsweek, Inc.
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
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