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