Diversification destroys value
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“Deconglomeration” around the world
Deconglomeration or “refocusing”
1. Asset sales
2. Spinoffs
3. Equity carve-outs
4. Tracking stock
5. Split-offs
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Asset sales
• Simplest, quickest, cheapest method of divesting an unwanted business
• Major problem: taxes
• Can sometimes be difficult to find a buyer
Example of a “bust-up” asset sale
• Beatrice’s LBO:
15% gain in asset value
3

Spinoffs
1.
A wholly-owned division of the parent is incorporated as a separate, stand-alone company.
2.
Stock in the company is issued as a dividend to shareholders of the parent.
3.
Stock begins to trade; ownership of the two companies separates over time.
4.
Generally a tax free transaction if requirements are met.
Pepsico stock rose 10.0% on 29 April 1997
An example
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Spinoff data
($ Millions)
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
Totals for 2002-06
US $196 billion
Europe $100 billion
Asia $30 billion
Returns to spinoffs
• Parent stock prices rise more than 5%, on average, when a spinoff is announced:
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Pepsi vs. Coca Cola
• Before the spinoff
(five years)
• Since the spinoff
Ex post performance of spinoffs
6

Tricon since the spinoff
Ex post performance of spinoffs
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Equity carve-outs
1. Business unit is placed into a separate corporation, just as in a spinoff
2. Stock is sold to the public in an initial public offering (IPO)
3. Usually only a minority of shares are sold
(often less than 20%), with remaining interest retained by parent
U.S. equity carve-outs, 1986-2001
20.0
15.0
10.0
5.0
0.0
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
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Example
Equity carve-outs
• Many carve-outs are done to “highlight the value” of a subsidiary that the market may be overlooking.
• Increasingly used as first step of a spinoff.
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Parent company stock price reactions
8%
7%
6%
5%
4%
3%
2%
1%
122 companies
0%
-1%
-2%
-10 -5 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90
Days
Carve-outs prior to spinoffs
• The problem: early selling pressure at time of spinoff distribution
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How carve-outs increase liquidity
• A base of interested shareholders exists already at time of spinoff distribution
• Greater research coverage of the stock
• Publicity effect of the IPO
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Evidence for liquidity effect
Source: Low, “A Study of Two-Step Spinoffs,” NYU Stern School 2001
Better analyst coverage
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Carve-outs and the Internet
• A large wave of tech carveouts were issued in 1999-
2001.
• Many of these carved out subsidiaries barely existed and were invented to capitalize on the Internet
IPO craze
DLJ Direct
Snap
Playboy.com
Barnesandnoble.com
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Can the market add and subtract?
3com’s carve-out of Palm
$40
$30
$20
$10
$60
$50
Palm
$53.4 bn
3Com carves out
6 percent of Palm; retains 94 percent and announces plan for spinoff
3Com
$28.6 bn
Spinoff date
$0
Jan '00 Feb Mar Apr May Jun Jul Aug '00
Carve-ins
• Many Internet carve-outs were issued with great fanfare and then bought back after the bubble burst, at a huge discount to the original IPO proceeds.
• Disney Internet Group (aka Go.com)
Market cap of $1.5 billion on IPO date,
November 18, 1999 (71% owned by parent)
Retired in an exchange offer for 85% less,
March 19, 2001
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Tracking stock
• Company issues a special class of common stock via a dividend or IPO
– Example: General Motors
Class E and Class H
• Annual dividend to holders of the tracking stock is determined by profitability of one business unit
• Usually has no voting rights
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Tracking stock
• Can be useful as an “acquisition currency”
• Can signal intention to dispose of the business in the future
• Announcement effect: avg. +2.5%
• Long-term investment performance is poor; no possibility of collecting takeover premium
Split-offs
• Example: Dupont and Conoco, 1998-99
– Conoco acquired in 1981; management decides to divest in 1998.
– 30% of shares sold in IPO for $4.4 billion
– 70% of shares offered to current Dupont shareholders in exchange offer
– Terms: 2.95 Conoco shares for 1 Dupont share; 18% premium
– Conoco acquired in 2001 by Phillips Petroleum
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Why use a split-off?
• Allows shareholders to separate into “clienteles” without taxes and trading costs that would accompany a spinoff
Capital structure and deconglomeration
• Separating the assets of a firm is usually straightforward
• Creating a capital structure for a divested firm is much more problematic
– Incentives for “risk shifting” are large
– “Agency costs of debt”
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Risk shifting in spinoffs
Marriott’s spinoff proposal (1992)
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Marriott’s spinoff proposal
• Widely interpreted as a transfer from debt to equity, leading to renegotiation.
• Today, “event risk” covenants are standard.
Marriott’s final spinoff (1993)
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