HARWARD BUSINESS SCHOOL

9-201-063

REV. MARCH 12, 2002

GREGOR ANDRADE

STUART GILSON

TODD PULVINO

I was assigned to answer question no. 1 for team A. Both market inefficiencies and agency costs caused
the discrepancy in market value between Seagates stock and the VERITAS stock on Seagates balance
sheet.

Market inefficiencies could come from two aspects, the under value of Seagate and the over value of
VERITAS. As mentioned in the case, besides the disk drive operations, Seagates main asset was a
significant ($21 billion) stake in VERITAS common stock. Since last summer, there is a major run up in
VERITAS stock price, making the market value of Seagates VERITAS stake had come to substantially
exceed Seagates entire market capitalization. That is to if the market value the VERITAS stock right, the
market value of Seagates disk drive operations is negative. Given the fact that Seagates disk drive
business has a large size and market-leading position, we think Seagate is undervalued. As the same
time, we also believe there is high possibility that VERITAS stock is overvalued. Another thing that might
cause this market inefficiency is investors maybe didnt notice Seagates stake in VERITAS.

In addition, agency costs might be another reason to explain the discrepancy in values. There are two
ways to turn the increase in value of VERITAS stock into the Seagates shareholders money, selling
VERITAS stock and then distributing cash to shareholders, or distributing VERITAS stock to shareholders.
Both ways would cause company and personal cost. Besides this, Seagates ability to sell off its VERITAS
stock was limited by prior agreement with VERITAS. Thus, converting the value of stake in VERITAS to
value of shareholders is not that easy. Maybe the market found this agency cost, so the stock price of
Seagate didnt increase as VERITAS. This agency costs explanation may weaken the market inefficiencies
explanation. However, we think two explanations both exit in this case.

The price we, the shareholders, wish to receive is $4,063.

The answers for each one question are provided as assumptions for other questions. For question 3, the
calculation of cost of capital needs D/E ratio, which is determined as capital structure in question 2. For
question 4, to value this asset needs to know how much cash flow can be generated from this asset. This
cash flow is from the calculation in question 1. In addition, the discount rate is connected to question 3,
which focuses on the calculation of cost of capital.
Details of the consistency of the assumptions and logic are shown in followings.

Consistency in Question 1 and question 4

We use the base Case as the baseline to project future cash flow, and make some improvements.

We use same data of projected financial statements.

Consistency in Question 2 and question 3

We referred to the exhibit 7 and exhibit 11, we think the upper limit of D/V should be 59.3%, thus the
company can raise money by maintaining an investment grade rating of B. We can expect that financial
leverage will be highest right after the deal closed, and decline over time as cash flows from asset sales
and operations are used to pay down the debt.

Consistency in Question 3 and question 4

PV factor used in Q4 is 11.84% which was quite close to 12.3%. PV factor for interest is 7.72 % which is
BBB corporate long-term bonds rate (see Exhibit 10).