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Sell offs_ Spin offs_ carve outs_ and tracking - Sell offs_ spin

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					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




                                                                New company B
 Shareholders 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 of
                                 Sub B equity                   X % of sub B equity sold
                                   Not 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
                   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

				
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