Sell offs, spin offs, carve outs and tracking stock

Corporate RestructuringTim Thompson

Defining divestitures

Selling assets, divisions, subsidiaries to another corporation or combination of corporations or individuals

Divestitures

Subsidiary B

Company A without Subsidiary B

Company C

Divestitures (2)

Company A w/o subsidiary B

Old Sub B

Company C

Cash, securities or assets as consideration

Features of divestitures

Selling corporation typically receives consideration for the assets sold cash securities other assets

Divestitures are typically taxable events for selling corporation (new basis for purchaser)

Spin offs

Typically parent corporation distributes on pro rata basis, all the shares it owns in subsidiary to its own shareholders.

No money generally changes hands Non taxable event

as long as it jumps through substantial hoops

Spin offs

Company A without Subsidiary B

Subsidiary B

Shareholders own shares of combined company. Own the equity in subsidiary implicitly.

Spin offs (2)

Company A after spinoff

New company BShareholders

receive Shares of

company B

Old shareholders still own shares of company A, which now only represent ownership of A without B.

Equity carve outs

Also called partial IPO Parent company sells a percentage

of the equity of a subsidiary to the public stock market

Receives cash for the percentage sold

Can sell any percentage, often just less than 20%, just less than 50%, are chosen.

Equity carve out (partial IPO)

Company A without subsidieary B

Subsidiary B

Shareholders implicitly own 100% of equity of subsidiary B through their Company A shares.

Equity carve out (partial IPO)

Company A without subsidieary B

Portion ofSub B equity

Not soldX % of sub B equity sold

To market for cashIn IPO

Shareholders now own 100% of Company A (without B)And (1-X)% of Company B implicitly

Through their company A shares

X % ofCompanyB shares

Motivations for transactions Market for corporate control

Asset are more valuable to alternative management team

Divestiture, spin off, carve out, tracking stock

Unlocking hidden value Stock market problem or management problem?

Improving management incentives Divestiture, spin off, carve out, tracking stock

Agency costs Divestiture, spin off, carve out, tracking stock

Moving assets to more highly valued user

Division no longer has a “strategic fit” Returning to the core business

(undiversifying) Buyers might simply be willing to pay

too much! Spin off, carve out, may set up a

subsequent control transaction Or the threat may improve incentives

Focus management

Part of undiversification Easier to run, more able to focus efforts

Superior performance measurement Because you can use direct equity for

compensation (divestiture?) By the stock market?

Reduction in bureaucracy/Decision making authority Internal capital markets/external cap markets

Unlocking hidden value

Creation of pure play Stock market issue, spin off/carve

out/tracking stock Market can’t value tobacco/food, steel/oil Makes a control play for sub easier later

Sell high! Internet subs in 1998-99 Biotech Gold subs/Japanese subs in late ’80’s

Other reasons Reduction in agency costs Tax/regulatory factors Bondholder wealth expropriation

Divestitures

Stock price reaction to sell off Statistically positive response (Table

10.5 in Gaughn), but small Pre-sell off performance is

contradictory Good performance, may be leakage Poor performance, may be reason for

restructuring

Post-sell off performance of parent Contradictory (Jain vs. Klein in Kaiser)

Motives for divestiture Kaplan and Weisbach

Change of focus or corporate strategy (43) Unit unprofitable or mistake (22) Sale to pay off leveraged finance (29) Antitrust (2) Need cash (3) Defend against takeover (1) Good price (3) Total (103)

Defensive divestitures

Company is worried about being taken over sells “crown jewels” so they’re not

attractive anymore does an leveraged recap and sells the dogs

More generally, divestitures follow leveraged acquisitions pay down debt and restructure company to

be most valuable going-forward

Divestitures: government requirements An acquisition by company C of

company A (which owns company B)

Company B and Company C may represent an antitrust problem

Buy company A agreeing to divest company B

Divesting business unit to managers All the above reasons are possible Less bureaucracy, may no longer

fit corp strategy Leveraged buyout benefits as well Can you get this with spin offs?

Divestiture vs. other restructuring In divestiture is that buyer pays cash (usually)

for the whole sub. Depends on price. If the price (after tax) is

better than spin off results, then sell. (May depend on strategic interests).

In divestiture, parent no longer controls. In divestiture, parent stuck with liabilities

buyer doesn’t want. Divestitures move with the M&A market

Bad bidders become good targets? Kaplan and Weisbach

271 large acquisitions completed 1971-1982

44% divested by 1982 Diversification acquisitions four times

more likely to be divested

Mitchell and Lehn Companies with “negative” responses to

acquisitions tend to divest more frequently Become takeover targets more frequently

Analysis Is division worth more to you or to

buyer? Present value of operating free cash flows

at divisional WACC Less divisional “debt” liabilities going with

buyer Compare with the after-tax, after-fees

divestiture proceeds Strategy value of keeping/divesting?

Buyers of acquired units In contrast to acquirers of public

companies Buyer’s stock price reaction to

acquisitions of units is small positive. Jain finds this temporary, but studies

of many more acquired units contradicts this finding.

Spin offs

Central features of spin offs Spin offs are a distribution of

subsidiary shares to parent company shareholders

As such, no money (necessarily) comes into the parent company as a result

No shares (or assets) of the subsidiary are sold to the market (IPO) or to acquirer (divestiture)

Distribution in most instances is tax free

Requirements for Tax-free Distributions Section 355 of IRC, “Distributions

of stock and securities of a controlled corporation” “transaction not used principally as

device for distribution of earnings and profit…,” I.e. a valid business purpose

active business requirement is met all of the stock of the controlled

corporation is distributed*

IRS Guidelines for Spinoffs

Generally acceptable business purposes: provide an equity interest to employees facilitate primary stock offering facilitate a borrowing cost savings, fit and focus, competition facilitate a tax free acquisition of the parent

(Morris Trust transaction) Risk reduction

What’s a Morris trust? Essentially it was a way to turn a

taxable divestiture into a tax free spin off with a subsequent tax free merger

Ability to do this has been substantially curtailed

Spin offs in 1990’s

1991-mid 1996, $100 bn in tax-free spin offs Probably another $100 bn since Huge ones

AT&T/Lucent Technologies/NCR GM/EDS

Most much smaller Internet subsidiaries of “bricks and mortar”

parents

Spin off studies Older studies (Kaiser)

Some evidence of pre-spin off postive performance (18%, Miles and Rosenfield)

Positive reaction on average (2%) Not due to wealth redistribution from bondholders

on average (Marriott?) Larger spin offs – larger % price reaction Cusatis, Miles and Woolridge

Post spinoff positive performance both for parent and subsidiary

Both more active in takeovers

Spun off entity performance On average, very good performance Just correcting for value losses from

earlier acquisitions? Not all spun off companies are stars

3M/Imation Interco/Converse & Florsheim Allen Group/TransPro Inc. Ralston Purina/Ralcorp Holdings

Some recent spin offs Pepsi/Tricon

Pepsi originally wanted to establish a captive channel for fountain beverage business, but found they needed to alleviate competitive barriers to expanding that business (many more restaurant chains)

Whitman Corporation/Hussman/Midas Conglomerate discount, conflicts among management

of divisions No synergies between bottlers/heavy industry/auto

service RJR/Nabisco Holdings

Tobacco litigation, discounting food company Carl Icahn, Bennet Lebow

How can spin offs generate money for parent? Borrow at the sub level and

dividend to parent pre spin off Borrow money sole recourse to

sub, proceeds go to parent Fraudulent conveyance problem? Do a carve out first: internet subs

Tax treatment of carve outs No shareholder tax, usually If selling newly issued sub shares,

then non taxable If selling shares owned by parent,

then taxable on gain! Why do the latter? Produce

income? Avon Japan (1987), USG?

Carve outs

Why sell a partial stake? Pure play

Get the stock market to understand business

Once unit is revalued, the parent will be revalued as well (still owns the rest)

Setting up a sale later Make it harder to pierce the veil

Other motives for carve outs Divisional managers incentives

Kraft/Phillip Morris Thermo Electron

Sell “hot” properties Gold subs in mid ’80’s Japanese subs in late ’80’s Internet subs in ’97-’99 Why not sell all of it?

Targeted stock

Special class of common stock designed to provide equity return linked to operating performance of a distinct business unit (targeted business)

Splits company’s operations into two (or more) publicly traded equity claims, but allows businesses to remain as wholly owned segments of parent organization.

Target stock vs. spin off

Spin off creates equity of subsidiary, but subsidiary is no longer owned by, or

controlled by the management of parent company

new spun off stock has no equity claim on the assets or cash flows of the old parent company

Target stock vs. carve out

Like a carve out, payoff on target stock is a function of the performance of the target business

Like a carve out, parent company mgmt usually maintains control over business, but control is 100% w/ target stock

Unlike carve out, the target shares are not subsidiary shares

Target stock is not stock of the targeted business Target stock is stock of the consolidated

company, not the targeted business (sub) Does not represent legal ownership interest

in the assets of the sub Receives dividend rights against computed

earnings of sub Voting rights (in decisions of corp) float as

function of market value of the equity of sub

Features of target stock

Reduces, but does not eliminate, cross-subsidization of business units

No legal separation or transfer of assets from corporation to sub

Target stock structure does not alter board or director composition or mgmt control of the corp

Features of target common Features in each target share have

to be decided: Notional allocation of debt, other

assets and liabilities How will joint costs be allocated? Proxy statement describing

amendments to corporate charter, shareholder vote req

Non taxable event

Distribution of target shares Pro rata stock dividend paid to existing

holders Sell target shares to new public

investors, with remainder held by parent proceeds retained by sub proceeds allocated elsewhere in company

Shares issued in acquisition of target company

Cash flow rights

Dividend policy subject to discretion of board

“Available dividend amount” = fixed dollar level adjusted over time to

net income, dividends or other distributions

fixed as % of target business net income attributable to Targeted shareholders

Same limits on dividends as usual

Voting rights

Floating voting rights proportional to market value of underlying

business Asset disposition and liquidation rights

in liquidation of corporation, distribution to shares would be in proportion to market value

if the parent sells the sub, net proceeds can be paid to target, or can exchange for target shares