Creating Value the Seagate Way

How do you unlock hidden value within your company? For disk drive designer and manufacturer Seagate Technology, the answer meant evaluating the company’s balance sheet as a potential source of total shareholder return (TSR). The result had an immediate effect and helped Seagate attract a different kind of investor.

The 2008 global financial crisis hit the technology industries especially hard. In particular, it forced Seagate to cut costs, shore up its balance sheet, and eliminate its dividends. The company also began to refocus on its core business. 

The cost cutting and refocus on core technology caused Seagate’s gross margins to grow nearly fourfold, from a low point of 7.5% in April 2009 to 27% by the end of the year. That greatly improved the company’s cash flow, but the executives had little room to maneuver.

A Closer Look at TSR

As the senior team at Seagate explored its options, CEO Stephen J. Luczo and CFO Patrick O’Malley realized that the strengthened balance sheet and healthy cash flows could be a resource for improving the company’s valuation and contributing to TSR. 

Transitions in the tech industries had fundamentally changed Seagate’s profile and value proposition for investors. The disk drive sector was maturing, and that was affecting growth rates. This made Seagate less attractive to investors looking for rapid growth and outsized returns. However, the company’s strong cash flow could appeal to another group of investors—the so-called growth at reasonable price, or GARP, investors. The challenge was figuring out how to attract this type of investor to the company’s stock. 

Seagate’s senior team worked with BCG to evaluate the most effective way to accomplish this. The company’s executives concluded that the best approach would be to reintroduce a significant dividend and raise it over time in order to combat the perception of uncertainty and risk in the business. BCG research showed that dividend increases typically have a much stronger positive impact on a company’s valuation multiple than stock buybacks do. 

In the short term, initiating a dramatic dividend would boost the company’s valuation, as investors arbitraged its high initial yield back to normal levels. In the long term, a large, consistent, and growing dividend would attract the GARP investors that were the natural long-term investor base for a company like Seagate in a mature and consolidating sector. And as hedge funds and other short sellers exited the stock, Seagate’s valuation would ultimately become less volatile. 

This approach was counterintuitive for technology companies at that time. Focusing almost exclusively on cash flow and the profit and loss statement is the “story of the Valley,” according to Luczo. Although things have changed somewhat since then, it was rare for a tech company to creatively use its balance sheet for anything other than reinvestment in R&D or M&A

The work that Seagate had done to build up its balance sheet gave it a new resource to create value. “We began using our balance sheet as a weapon or a tool,” said O’Malley.

A Move That Sparked a Turnaround

In early April 2011, Seagate announced it would begin paying out an annual dividend of 86 cents per share. That created an initial dividend yield on the date of announcement of 5.4%. The decision had an immediate impact on the company’s stock price, as Seagate’s high yield attracted many more investors to the stock. In the first two weeks after the dividend announcement, Seagate’s stock price increased by nearly 25%, at a time when average gains in the S&P 500 were stagnant. The long-term results are also impressive: from 2009-2013, the company averaged an annual TSR of 70.3%.

This focus on TSR led Seagate’s senior executives to reinvent their mindset about the business and to reconsider how best to drive value. “We were forced to take a TSR perspective,” says O’Malley. “In 2009, our balance sheet was the albatross around our neck. Now, it’s a phoenix. We are focused on how we can use this balance sheet to do what we need to do. Today, we look at everything on that balance sheet as a potential source of TSR. We are determined to be good stewards of capital.”