© timothy a. thompson, 20071 sell offs, spin offs, carve outs and tracking stock corporate...

© Timothy A. Thompson, 2007

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Sell offs, spin offs, carve outs and tracking stock

Corporate RestructuringTim Thompson


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Defining divestitures

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


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Divestitures

Subsidiary B

Company A without Subsidiary B

Company C


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Divestitures (2)

Company A w/o subsidiary B

Old Sub B

Company C

Cash, securities or assets as consideration


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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)


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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


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Spin offs

Company A without Subsidiary B

Subsidiary B

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


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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.


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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.


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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.


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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


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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


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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


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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


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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


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


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Divestitures


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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)


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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)


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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


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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


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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?


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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


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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


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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?


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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.


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Spin offs


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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


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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 Parent must control and must distribute control*

80% of control, not nec. 80% of market value Continuity of interest and control requirement Sub cannot have been acquired in last five years by parent in

taxable transaction Divesting parent or spun-off sub cannot be acquired within two

years of spin off, or spin off loses tax free status


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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


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What if the spin off is taxable? Corporate level

Parent corporation recognizes a gain equal to the difference between the fair market value of property distributed less the parent’s tax basis in the net assets of the divested sub

Can be very large or small, depending on the size of the gain

Shareholder level Dividend taxable at ordinary rates, equal to the fair market

value of the property received, that is, the fair market value of the spun off sub

Spin offs that fail to qualify are generally, cancelled


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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 Spin off assets you want to keep to your shareholders in

tax free spin off Remaining assets are a sub you wanted to divest Acquirer buys the remaining assets in tax free merger and

avoided taxable aspect of divestiture Two-year no acquisition of parent intended to eliminate

the “Monetizing Morris Trust” transaction


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Spin off as takeover defense Hostile suitor

Spin off a division with highly appreciated assets

Acquirer buys parent triggers prior spin off to be taxable

Tax “poison pill” ITT threatened this in battle with

Hilton


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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


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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


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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


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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


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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


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Variants of spin offs Split offs

Divesting parent corporation distributes stock in sub to its shareholders in exchange for some of their parent stock

Exchange may or may not be pro rata May avoid 355 entirely


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Limited split off Abercrombie and Fitch Dutch auction

Limited’s shareholders specify an exchange ratio, within a range, under which they would exchange a share of Limited for a fraction of a A&F share (.73-.86)

After tabulation, Limited finds the ratio for which they can distribute 90% of A&F stock, probably won’t be prorata

Exchanging shareholders probably get a premium, with no tax

Benefits Shareholders can rearrange holdings in parent tax free Also, because the split off effects a buyback, there is

less EPS dilution than a spin off


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Equity Carve Outs


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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?


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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


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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?


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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.


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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


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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


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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


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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


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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


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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


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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


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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

© timothy a. thompson, 20071 sell offs, spin offs, carve outs and tracking stock corporate...

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