Sell offs, spin offs, carve

outs and tracking stock

Corporate Restructuring
Tim Thompson

Defining divestitures

Selling assets, divisions,

subsidiaries to another corporation
or combination of corporations or
individuals

Divestitures
Company A without Subsidiary B

Subsidiary B

Company C

Divestitures (2)
Company A w/o subsidiary B

Cash, securities or assets as

consideration

Old Sub B
Company C

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

Shareholders
receive
Shares of
company B

New 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 of
Sub B equity
Not sold

X % of sub B equity sold

To market for cash
In IPO
X % of
Company
B shares

Shareholders now own 100% of Company A (without B)

And (1-X)% of Company B implicitly
Through their company A shares

Motivations for
transactions

Market for corporate control

Asset are more valuable to alternative

management team

Unlocking hidden value

Stock market problem or management problem?

Improving management incentives

Divestiture, spin off, carve out, tracking stock

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

Superior performance measurement

Easier to run, more able to focus efforts

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 cant 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 80s

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 theyre 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 doesnt want.
Divestitures move with the M&A market

Bad bidders become good

targets?

Kaplan and Weisbach

271 large acquisitions completed 19711982

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

Buyers 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

Whats 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 1990s

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

Whitman Corporation/Hussman/Midas

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)
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
Borrow at the sub level and
parent?

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 80s

Japanese subs in late 80s
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 companys 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