Case No: 9-297-052, Note No: 5-297-093
Posted: 31 Mar 1998
Date Written: July 12, 1997 and March 6, 1997
SUBJECT AREAS: Valuation by discounted cash flow and multiples, leveraged recapitalization, cyclicality and valuation errors, impacts of extreme leverage, market for corporate control CASE SETTING: May 1988, USA, building materials, $2.9 billion revenue, 22,200 employees
In 1988, USG was the world's largest manufacturer of gypsum products including "sheetrock," USG's trademark product name. Despite being the market leader, and being ranked seventh on the Fortune 500 in terms of return on equity (ROE) and fourteenth in terms of 10-year earnings per share (EPS) growth, USG became the target of two hostile takeover attempts between 1986 and 1988. USG paid greenmail in November 1986 to escape the first attempt. The case is set after USG's board has proposed, but shareholders have not yet approved, a leveraged recapitalization to thwart the second offer. Students, as shareholders, must decide whether to tender their shares or wait and vote in favor of the recapitalization plan.
The USG Corporation case analyzes a defensive leveraged recapitalization and illustrates the capital cash flow methodology for valuing highly leveraged transactions. It highlights the complexity of valuing cyclical companies and the potential errors made by ignoring cyclicality in cash flow projections. The facts in this case are consistent with Kaplan and Stein's (1993) theory of overheating in buyout pricing during the late 1980s and Palepu and Wruck's (1992) documentation of poor ex post performance in defensive recapitalizations. When paired with a discussion of voluntary recapitalizations, it also allows the instructor to compare voluntary versus defensive recapitalizations in terms of ex ante incentives and ex post performance.
Although this case was originally written as a final exam for an advanced corporate finance class, it has been used regularly for class discussion with MBA students and executives in course on valuation. This case was featured in the 1998 Graduate Business School Finance Case Competition sponsored by Carnegie Mellon.
JEL Classification: G34, L73
Suggested Citation: Suggested Citation