Sell offs, Spin offs, carve outs, and tracking stock


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  • Generally, if the parent sells more than 20% of the stock to the market, the parent loses the ability to subsequently spin off the remainder of the stock to their shareholders in a tax free transaction. With dual class shares outstanding, where each class possesses identical attributes except in connection with voting power, and if the parent retains the high voting power relative to the shares sold to the market, the parent can sell more than 20% to the market and still retain the opportunity to subsequently spin off the rest of the shares to their shareholders in tax free spin off. Requirement that mandates parent control the spunoff sub immediately prior to the spin off. 80 percent of the total combined voting power of all class of stock will do. Abercrombie and Fitch, Limited. Limited can sell as much as 40% of A+F and still meet requirements.
  • These sources of gains are not equally gains from divestitures/spin offs/carve outs. They are all offered as potential gains from separating the parent from the subsidiary and may not apply to all types of split ups.
  • Bally’s spin off of Bally’s Health and Tennis Corporation justified spin off business purpose due to reduction in regulation expenses -- had to license all its officers/directors, personal investigation, because of gaming.
  • Getty Petroleum breaks itself into a real estate company and a gasoline retailing operating, via a tax free spinoff. Does real estate operation qualify as an active trade or business? The real estate, namely gas stations, will be owned by Getty Realty Corp, however the stations will be leased back to Getty Petroleum Marketing Inc. Regulations now say that, with regard to real estate a corporation rents/leases to others, the corporation will only be viewed as active if it “performs significant servies” and “substantial management and operational functions directly.” Frequently, active business requirement can only be satisfied if an investment banker certifies to IRS that the client’s business objective is attainable. ITT spun off insurance from automotive and entertainment, then entertainment from automotive. I-Bankers argued that automotive and entertainment needed to raise debt capital (cheaper source) to finance growth opportunities, but this conflicted with insurance ratings. For 2nd spin off, argued that entertainment needed to raise equity in order to finance acquisitions (P/E multiples would expand if it was separated from automotive so that equity could be raised!)
  • Sell offs, Spin offs, carve outs, and tracking stock

    1. 1. Sell offs, spin offs, carve outs and tracking stock Corporate Restructuring Tim Thompson
    2. 2. Defining divestitures <ul><li>Selling assets, divisions, subsidiaries to another corporation or combination of corporations or individuals </li></ul>
    3. 3. Divestitures Company before divestiture Subsidiary B Company A without Subsidiary B Company C Buying company
    4. 4. Divestitures (2) Company after divestiture Company A w/o subsidiary B Old Sub B Company C Cash, securities or assets as consideration What does Company A do with consideration?
    5. 5. Features of divestitures <ul><li>Selling corporation typically receives consideration for the assets sold </li></ul><ul><ul><li>cash </li></ul></ul><ul><ul><li>securities </li></ul></ul><ul><ul><li>other assets </li></ul></ul><ul><li>Divestitures are typically taxable events for selling corporation (new basis for purchaser) </li></ul>
    6. 6. Spin offs <ul><li>Typically parent corporation distributes on pro rata basis, all the shares it owns in subsidiary to its own shareholders. </li></ul><ul><li>No money generally changes hands </li></ul><ul><li>Non taxable event </li></ul><ul><ul><li>as long as it jumps through substantial hoops </li></ul></ul>
    7. 7. Spin offs Company A without Subsidiary B Subsidiary B Company before spin off Shareholders Shareholders own shares of combined company. Own the equity in subsidiary implicitly.
    8. 8. Spin offs (2) Company A after spinoff New company B Shareholders Shareholders receive Shares of company B Old shareholders still own shares of company A, which now only represent ownership of A without B. Company after spin off
    9. 9. Equity carve outs <ul><li>Also called partial IPO </li></ul><ul><li>Parent company sells a percentage of the equity of a subsidiary to the public stock market </li></ul><ul><li>Receives cash for the percentage sold </li></ul><ul><li>Can sell any percentage, often just less than 20%, just less than 50%, are chosen. </li></ul>
    10. 10. Equity carve out (partial IPO) Company A without subsidieary B Subsidiary B Company before carve out Shareholders Stock market Shareholders implicitly own 100% of equity of subsidiary B through their Company A shares.
    11. 11. Equity carve out (partial IPO) Company A without subsidieary B Company after carve out Shareholders Stock market Portion of Sub B equity Not sold X % of sub B equity sold To market for cash In IPO Shareholders now own 100% of Company A (without B) And (1-X)% of Company B implicitly Through their company A shares X % of Company B shares
    12. 12. Motivations for transactions <ul><li>Market for corporate control </li></ul><ul><ul><ul><li>Asset are more valuable to alternative management team </li></ul></ul></ul><ul><ul><ul><ul><ul><li>Divestiture, spin off, carve out, tracking stock </li></ul></ul></ul></ul></ul><ul><li>Unlocking hidden value </li></ul><ul><ul><ul><li>Stock market problem or management problem? </li></ul></ul></ul><ul><li>Improving management incentives </li></ul><ul><ul><ul><ul><ul><li>Divestiture, spin off, carve out, tracking stock </li></ul></ul></ul></ul></ul><ul><li>Agency costs </li></ul><ul><ul><ul><ul><ul><li>Divestiture, spin off, carve out, tracking stock </li></ul></ul></ul></ul></ul>
    13. 13. Moving assets to more highly valued user <ul><ul><li>Division no longer has a “strategic fit” </li></ul></ul><ul><ul><li>Returning to the core business (undiversifying) </li></ul></ul><ul><ul><li>Buyers might simply be willing to pay too much! </li></ul></ul><ul><ul><li>Spin off, carve out, may set up a subsequent control transaction </li></ul></ul><ul><ul><ul><ul><li>Or the threat may improve incentives </li></ul></ul></ul></ul>
    14. 14. Focus management <ul><li>Part of undiversification </li></ul><ul><ul><ul><li>Easier to run, more able to focus efforts </li></ul></ul></ul><ul><li>Superior performance measurement </li></ul><ul><ul><li>Because you can use direct equity for compensation (divestiture?) </li></ul></ul><ul><ul><li>By the stock market? </li></ul></ul><ul><li>Reduction in bureaucracy/Decision making authority </li></ul><ul><ul><li>Internal capital markets/external cap markets </li></ul></ul>
    15. 15. Unlocking hidden value <ul><li>Creation of pure play </li></ul><ul><ul><li>Stock market issue, spin off/carve out/tracking stock </li></ul></ul><ul><ul><li>Market can’t value tobacco/food, steel/oil </li></ul></ul><ul><ul><li>Makes a control play for sub easier later </li></ul></ul><ul><li>Sell high! </li></ul><ul><ul><li>Internet subs in 1998-99 </li></ul></ul><ul><ul><li>Biotech </li></ul></ul><ul><ul><li>Gold subs/Japanese subs in late ’80’s </li></ul></ul>
    16. 16. Other reasons <ul><li>Reduction in agency costs </li></ul><ul><li>Tax/regulatory factors </li></ul><ul><li>Bondholder wealth expropriation </li></ul>
    17. 17. Divestitures
    18. 18. Stock price reaction to sell off <ul><li>Statistically positive response (Table 10.5 in Gaughn), but small </li></ul><ul><li>Pre-sell off performance is contradictory </li></ul><ul><ul><ul><li>Good performance, may be leakage </li></ul></ul></ul><ul><ul><ul><li>Poor performance, may be reason for restructuring </li></ul></ul></ul><ul><li>Post-sell off performance of parent </li></ul><ul><ul><ul><li>Contradictory (Jain vs. Klein in Kaiser) </li></ul></ul></ul>
    19. 19. Motives for divestiture <ul><li>Kaplan and Weisbach </li></ul><ul><ul><ul><li>Change of focus or corporate strategy (43) </li></ul></ul></ul><ul><ul><ul><li>Unit unprofitable or mistake (22) </li></ul></ul></ul><ul><ul><ul><li>Sale to pay off leveraged finance (29) </li></ul></ul></ul><ul><ul><ul><li>Antitrust (2) </li></ul></ul></ul><ul><ul><ul><li>Need cash (3) </li></ul></ul></ul><ul><ul><ul><li>Defend against takeover (1) </li></ul></ul></ul><ul><ul><ul><li>Good price (3) </li></ul></ul></ul><ul><ul><ul><li>Total (103) </li></ul></ul></ul>
    20. 20. Defensive divestitures <ul><li>Company is worried about being taken over </li></ul><ul><ul><li>sells “crown jewels” so they’re not attractive anymore </li></ul></ul><ul><ul><li>does an leveraged recap and sells the dogs </li></ul></ul><ul><li>More generally, divestitures follow leveraged acquisitions </li></ul><ul><ul><li>pay down debt and restructure company to be most valuable going-forward </li></ul></ul>
    21. 21. Divestitures: government requirements <ul><li>An acquisition by company C of company A (which owns company B) </li></ul><ul><li>Company B and Company C may represent an antitrust problem </li></ul><ul><li>Buy company A agreeing to divest company B </li></ul>
    22. 22. Divesting business unit to managers <ul><li>All the above reasons are possible </li></ul><ul><li>Less bureaucracy, may no longer fit corp strategy </li></ul><ul><li>Leveraged buyout benefits as well </li></ul><ul><li>Can you get this with spin offs? </li></ul>
    23. 23. Divestiture vs. other restructuring <ul><li>In divestiture is that buyer pays cash (usually) for the whole sub. </li></ul><ul><li>Depends on price. If the price (after tax) is better than spin off results, then sell. (May depend on strategic interests). </li></ul><ul><li>In divestiture, parent no longer controls. </li></ul><ul><li>In divestiture, parent stuck with liabilities buyer doesn’t want. </li></ul><ul><li>Divestitures move with the M&A market </li></ul>
    24. 24. Bad bidders become good targets? <ul><li>Kaplan and Weisbach </li></ul><ul><ul><ul><li>271 large acquisitions completed 1971-1982 </li></ul></ul></ul><ul><ul><ul><li>44% divested by 1982 </li></ul></ul></ul><ul><ul><ul><li>Diversification acquisitions four times more likely to be divested </li></ul></ul></ul><ul><li>Mitchell and Lehn </li></ul><ul><ul><ul><ul><li>Companies with “negative” responses to acquisitions tend to divest more frequently </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Become takeover targets more frequently </li></ul></ul></ul></ul>
    25. 25. Analysis <ul><li>Is division worth more to you or to buyer? </li></ul><ul><ul><ul><li>Present value of operating free cash flows at divisional WACC </li></ul></ul></ul><ul><ul><ul><li>Less divisional “debt” liabilities going with buyer </li></ul></ul></ul><ul><ul><ul><li>Compare with the after-tax, after-fees divestiture proceeds </li></ul></ul></ul><ul><li>Strategy value of keeping/divesting? </li></ul>
    26. 26. Buyers of acquired units <ul><li>In contrast to acquirers of public companies </li></ul><ul><ul><li>Buyer’s stock price reaction to acquisitions of units is small positive. </li></ul></ul><ul><ul><li>Jain finds this temporary, but studies of many more acquired units contradicts this finding. </li></ul></ul>
    27. 27. Spin offs
    28. 28. Central features of spin offs <ul><li>Spin offs are a distribution of subsidiary shares to parent company shareholders </li></ul><ul><ul><ul><li>As such, no money (necessarily) comes into the parent company as a result </li></ul></ul></ul><ul><ul><ul><li>No shares (or assets) of the subsidiary are sold to the market (IPO) or to acquirer (divestiture) </li></ul></ul></ul><ul><li>Distribution in most instances is tax free </li></ul>
    29. 29. Requirements for Tax-free Distributions <ul><li>Section 355 of IRC, “Distributions of stock and securities of a controlled corporation” </li></ul><ul><ul><li>“transaction not used principally as device for distribution of earnings and profit…,” I.e. a valid business purpose </li></ul></ul><ul><ul><li>active business requirement is met </li></ul></ul><ul><ul><li>all of the stock of the controlled corporation is distributed* </li></ul></ul>
    30. 30. IRS Guidelines for Spinoffs <ul><li>Generally acceptable business purposes: </li></ul><ul><ul><li>provide an equity interest to employees </li></ul></ul><ul><ul><li>facilitate primary stock offering </li></ul></ul><ul><ul><li>facilitate a borrowing </li></ul></ul><ul><ul><li>cost savings, fit and focus, competition </li></ul></ul><ul><ul><li>facilitate a tax free acquisition of the parent (Morris Trust transaction) </li></ul></ul><ul><ul><li>Risk reduction </li></ul></ul>
    31. 31. What’s a Morris trust? <ul><li>Essentially it was a way to turn a taxable divestiture into a tax free spin off with a subsequent tax free merger </li></ul><ul><li>Ability to do this has been substantially curtailed </li></ul>
    32. 32. Spin offs in 1990’s <ul><li>1991-mid 1996, $100 bn in tax-free spin offs </li></ul><ul><li>Probably another $100 bn since </li></ul><ul><li>Huge ones </li></ul><ul><ul><li>AT&T/Lucent Technologies/NCR </li></ul></ul><ul><ul><li>GM/EDS </li></ul></ul><ul><li>Most much smaller </li></ul><ul><li>Internet subsidiaries of “bricks and mortar” parents </li></ul>
    33. 33. Spin off studies <ul><li>Older studies (Kaiser) </li></ul><ul><ul><ul><li>Some evidence of pre-spin off postive performance (18%, Miles and Rosenfield) </li></ul></ul></ul><ul><ul><ul><li>Positive reaction on average (2%) </li></ul></ul></ul><ul><ul><ul><li>Not due to wealth redistribution from bondholders on average (Marriott?) </li></ul></ul></ul><ul><ul><ul><li>Larger spin offs – larger % price reaction </li></ul></ul></ul><ul><ul><ul><li>Cusatis, Miles and Woolridge </li></ul></ul></ul><ul><ul><ul><ul><li>Post spinoff positive performance both for parent and subsidiary </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Both more active in takeovers </li></ul></ul></ul></ul>
    34. 34. Spun off entity performance <ul><li>On average, very good performance </li></ul><ul><li>Just correcting for value losses from earlier acquisitions? </li></ul><ul><li>Not all spun off companies are stars </li></ul><ul><ul><li>3M/Imation </li></ul></ul><ul><ul><li>Interco/Converse & Florsheim </li></ul></ul><ul><ul><li>Allen Group/TransPro Inc. </li></ul></ul><ul><ul><li>Ralston Purina/Ralcorp Holdings </li></ul></ul>
    35. 35. Some recent spin offs <ul><li>Pepsi/Tricon </li></ul><ul><ul><li>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) </li></ul></ul><ul><li>Whitman Corporation/Hussman/Midas </li></ul><ul><ul><li>Conglomerate discount, conflicts among management of divisions </li></ul></ul><ul><ul><li>No synergies between bottlers/heavy industry/auto service </li></ul></ul><ul><li>RJR/Nabisco Holdings </li></ul><ul><ul><li>Tobacco litigation, discounting food company </li></ul></ul><ul><ul><li>Carl Icahn, Bennet Lebow </li></ul></ul>
    36. 36. How can spin offs generate money for parent? <ul><li>Borrow at the sub level and dividend to parent pre spin off </li></ul><ul><li>Borrow money sole recourse to sub, proceeds go to parent </li></ul><ul><li>Fraudulent conveyance problem? </li></ul><ul><li>Do a carve out first: internet subs </li></ul>
    37. 37. Tax treatment of carve outs <ul><li>No shareholder tax, usually </li></ul><ul><li>If selling newly issued sub shares, then non taxable </li></ul><ul><li>If selling shares owned by parent, then taxable on gain! </li></ul><ul><li>Why do the latter? Produce income? </li></ul><ul><ul><ul><li>Avon Japan (1987), USG? </li></ul></ul></ul>
    38. 38. Carve outs <ul><li>Why sell a partial stake? </li></ul><ul><li>Pure play </li></ul><ul><ul><li>Get the stock market to understand business </li></ul></ul><ul><ul><li>Once unit is revalued, the parent will be revalued as well (still owns the rest) </li></ul></ul><ul><ul><li>Setting up a sale later </li></ul></ul><ul><li>Make it harder to pierce the veil </li></ul>
    39. 39. Other motives for carve outs <ul><li>Divisional managers incentives </li></ul><ul><ul><ul><li>Kraft/Phillip Morris </li></ul></ul></ul><ul><ul><ul><li>Thermo Electron </li></ul></ul></ul><ul><li>Sell “hot” properties </li></ul><ul><ul><ul><li>Gold subs in mid ’80’s </li></ul></ul></ul><ul><ul><ul><li>Japanese subs in late ’80’s </li></ul></ul></ul><ul><ul><ul><li>Internet subs in ’97-’99 </li></ul></ul></ul><ul><ul><ul><li>Why not sell all of it? </li></ul></ul></ul>
    40. 40. Targeted stock <ul><li>Special class of common stock designed to provide equity return linked to operating performance of a distinct business unit (targeted business) </li></ul><ul><li>Splits company’s operations into two (or more) publicly traded equity claims, but allows businesses to remain as wholly owned segments of parent organization. </li></ul>
    41. 41. Target stock vs. spin off <ul><li>Spin off creates equity of subsidiary, but </li></ul><ul><ul><li>subsidiary is no longer owned by, or controlled by the management of parent company </li></ul></ul><ul><ul><li>new spun off stock has no equity claim on the assets or cash flows of the old parent company </li></ul></ul>
    42. 42. Target stock vs. carve out <ul><li>Like a carve out, payoff on target stock is a function of the performance of the target business </li></ul><ul><li>Like a carve out, parent company mgmt usually maintains control over business, but control is 100% w/ target stock </li></ul><ul><li>Unlike carve out, the target shares are not subsidiary shares </li></ul>
    43. 43. Target stock is not stock of the targeted business <ul><li>Target stock is stock of the consolidated company, not the targeted business (sub) </li></ul><ul><ul><li>Does not represent legal ownership interest in the assets of the sub </li></ul></ul><ul><ul><li>Receives dividend rights against computed earnings of sub </li></ul></ul><ul><ul><li>Voting rights (in decisions of corp) float as function of market value of the equity of sub </li></ul></ul>
    44. 44. Features of target stock <ul><li>Reduces, but does not eliminate, cross-subsidization of business units </li></ul><ul><li>No legal separation or transfer of assets from corporation to sub </li></ul><ul><li>Target stock structure does not alter board or director composition or mgmt control of the corp </li></ul>
    45. 45. Features of target common <ul><li>Features in each target share have to be decided: </li></ul><ul><ul><li>Notional allocation of debt, other assets and liabilities </li></ul></ul><ul><ul><li>How will joint costs be allocated? </li></ul></ul><ul><ul><li>Proxy statement describing amendments to corporate charter, shareholder vote req </li></ul></ul><ul><ul><li>Non taxable event </li></ul></ul>
    46. 46. Distribution of target shares <ul><li>Pro rata stock dividend paid to existing holders </li></ul><ul><li>Sell target shares to new public investors, with remainder held by parent </li></ul><ul><ul><li>proceeds retained by sub </li></ul></ul><ul><ul><li>proceeds allocated elsewhere in company </li></ul></ul><ul><li>Shares issued in acquisition of target company </li></ul>
    47. 47. Cash flow rights <ul><li>Dividend policy subject to discretion of board </li></ul><ul><li>“Available dividend amount” = </li></ul><ul><ul><li>fixed dollar level adjusted over time to net income, dividends or other distributions </li></ul></ul><ul><ul><li>fixed as % of target business net income attributable to Targeted shareholders </li></ul></ul><ul><li>Same limits on dividends as usual </li></ul>
    48. 48. Voting rights <ul><li>Floating voting rights </li></ul><ul><ul><li>proportional to market value of underlying business </li></ul></ul><ul><li>Asset disposition and liquidation rights </li></ul><ul><ul><li>in liquidation of corporation, distribution to shares would be in proportion to market value </li></ul></ul><ul><ul><li>if the parent sells the sub, net proceeds can be paid to target, or can exchange for target shares </li></ul></ul>