Desert Partners Case Summary

. How should Day respond to Desert Partner's tender offer?

Day has to think in terms of maximizing shareholder value. Day should reject the offer and here is why –

USG has been a takeover target in the past driven by its steady cash flow, low operating costs, strong market share and thought to be undervalued by many analysts.

Any take over is possible for the right price – if at all rejecting the takeover bid will strengthen USG's negotiation strategy and encourage the tendering company to increase their price. The bid was considered to be unsolicited, coercive and inadequate.

Desert Partners has indicated a willingness to increase their tender offer to $50.00 per share in cash, debt, and stock. This change is not official and we feel that this makes their true intentions uncertain.
If Desert Partners is going to increase their offer to $50.00 with sufficient certainty, then the takeover plan may be more advantageous than the recapitalization plan from the USG shareholders perspective.

USG has to seriously consider the viable option of implementing the proposed recapitalization. USG's board of directors proposed a leveraged recapitalization that would pay a cash dividend of $37 per share, $5 per share in the form of a payment-in-kind debenture and stub stock.
Day should weigh the value to shareholders under both plans and decide which one will give the best shareholder benefit.

Is the proposed recapitalization the best response?

There are two answers to this question. USG's board debated a number of alternatives. They considered repurchasing additional stock, selling equity to a friendly third party or selling the entire company to a friendly acquirer. In fact, U.K. based BPB industries was a possible ‘White Knight".

However, analysts have also drawn attention to the fact that the proposed recapitalization would burden the company with debt, forcing it to sell profitable business units. USG will go from a company that is virtually debt-free to one overburdened by leverage. This decision will saddle the company with more than $3 billion in debt and high interest payments. Although, we must not forget that the higher debt will also reward USG with a substantial tax shield.

The recapitalization is intended to provide shareholders with a significant distribution of cash and securities and permit them to retain their proportionate long term equity interest in the
company.

The operating changes associated with the recapitalization would install a new performance incentive plan for about 215 senior managers and amend the current benefits and stock option plans. The company would also discontinue any products and distribution channels that failed to pass certain stricter investment criteria. It would also reduce capital and operating expenses by $100 million and $70 million respectively.

Is USG a good candidate for leveraged recapitalization?

In corporate finance, a leveraged recapitalization is a strategy often used to fend off a hostile acquisition. Under this strategy, a company incurs significant additional debt to repurchase stocks through a buyback program or distribute a large dividend among the current shareholders. This will cause the share price to drop significantly, making the company a less attractive takeover target.

Because each USG company is a market leader, USG has been deemed as suitable to manage operations with a higher leveraged balance sheet.

In support of this statement Day hired American Appraisal Capital Services Inc,. to review the proposed transaction. They came back reporting that the fair salable value of the company's assets would exceed the company's states liabilities and that the company would be able to pay its obligations. Based on the projected financial data in Exhibit 7, USG is well positioned to manage operations with a leveraged balance sheet since the fair salable value of its assets would exceed its stated liabilities.

USG's net assets were a projected $995 million at the end of 1988, and a projected $1,075 million at the end of 1992, representing an 8% increase over a four-year period. USG would thus be able to pay its obligations as they became due, and the company would not have an unreasonably small capital base to conduct its business after the recapitalization.

For these reasons, as long as the projected financial data is reasonably accurate, (judging by our assessment of trends in managements overall performance), the projected financial data does seem reasonable. We believe that USG is a suitable candidate for the proposed leveraged recapitalization.