7,8,9
Corporate restructuring: the process of making changes in the composition of a firm’s one or
more business portfolios in order to have a more profitable enterprise.
Reasons for corporate restructuring:







To induce higher earnings
To leverage core competencies
Divestiture and networking
To ensure clarity in vision, strategy and structure
To provide proactive leadership
Employee empowerment
Re-engineering process
Types of corporate restructuring:
1.
2.
3.
4.
5.
divestitures,
equity carve-outs,
spinoffs,
split-offs,
and split-ups
Divestiture: A Divestiture is a sale of a portion of the firm to an outside party. The selling firm is
usually paid in cash, marketable securities, or a combination of the two.
The most common form of divestiture involves the sale of a division of the parent company to
another firm. The process is a form of contraction for the selling company but a means of
expansion for the purchasing corporation.
Two types of divestitures may occur:
1. Involuntary Divestitures
2. Voluntary Divestitures.
Reasons for Voluntary Divestitures
1. Poor Strategic Fit of Division: The parent company may want to move out of a
particular line of business that it feels no longer fits into its overall strategic plans.
2. Poor Performance: Companies may want to divest divisions simply because they are not
sufficiently profitable. The performance may be judged by an inability to pay a rate of
return that exceeds the parent company’s hurdle rate—the minimum return threshold
that a company will use to evaluate projects or the performance of parts of the overall
company. A typical hurdle rate could be the firm’s cost of capital.
An example of this occurred in 2014, when Procter & Gamble, the world’s largest maker
of consumer products, announced that it would initiate a program to sell off up to 100
of its brands. This would leave the company with approximately 70 to 80 brands. These
70 to 80 brands generate about 95% of the company’s profitability. It badly needed to
cut costs and get rid of weaker-performing brands.
3. Reverse Synergy: Reverse synergy means that the parts are worth more separately than
they are within the parent company’s corporate structure. For instance, a large parent
company is not able to operate a division profitably, whereas a smaller firm, or even the
division by itself, might operate more efficiently and therefore earn a higher rate of
return.
Example: in the late 1980s Allegis Corporation was forced to sell off its previously
acquired companies, Hertz Rent A Car and the Weston and Hilton International hotel
chains. Allegis had paid a high price for these acquisitions based on the belief that the
synergistic benefits of combining the travel industry companies with United Airlines, its
main asset, would more than justify the high prices. When the synergistic benefits failed
to materialize, the stock price fell, setting the stage for a hostile bid from the New York
investment firm Coniston Partners. Coniston made a bid based on its analysis that the
seperate parts of Allegis were worth more than the combined entity.
4. Capital Market Factors: A divestiture may also take place because the post divestiture
firm, as well as the divested division, has greater access to capital markets.
The combined corporate structure may be more difficult for investors to categorize. For
example, someone might be looking to invest in steel companies but not in
pharmaceutical firms. Others might seek to invest capital in pharmaceutical companies
but may think that the steel industry is too cyclical and has low growth potential. These
two groups of investors might not want to invest in a combined steel and
pharmaceutical company, but each group might separately invest in a stand-alone steel
or pharmaceutical firm. Divestitures might provide greater access to capital markets for
the two firms as separate companies than as a combined corporation.
It may create companies in which investors would like to invest but that do not exist in
the marketplace. Such companies are sometimes referred to as pure plays. Many
analysts argue that the market is incomplete and that there is a demand for certain
types of firms that is not matched by a supply of securities in the market. The sale of
those parts of the parent company that become pure plays helps complete the market.
The separation of divisions facilitates clearer identification and market segmentation for
the investment community.
5. Cash Flow Needs: Company may sell off even a well-performing unit if it encounters
pressing cash flow needs and if the unit is not essential to its corporate strategy. A selloff may produce the immediate benefits of an infusion of cash from the sale. The selling
firm is selling a long-term asset, which generated a certain cash flow per period, in
exchange for a larger payment in the short run. Companies that are under financial
duress are often forced to sell off valuable assets to enhance cash flows.
Example: International Harvester (now known as Navistar) sold its profitable Solar
Turbines International Division to Caterpillar Tractor Company Inc. to realize the
immediate proceeds of $505 million. These funds were used to cut Harvester’s shortterm debt in half.
6. Abandoning the Core Business: If management believe that the firm is in maturity stage
and only a few opportunities are available then, they may sell the core business.
An example of the sale of a core business was the 1987 sale by Greyhound of its bus
business. The firm has usually already diversified into other more profitable areas, and
the sale of the core business may help finance the expansion of these more productive
activities.
7. Liquidity of the Market for Corporate Assets: An obvious factor that should affect the
likelihood that a firm may divest a unit is the strength of the demand for that unit. This
reasonably would not be the primary factor as one would think that business strategy
and financial performance would play a more prominent role.
How market liquidity affects divesting decisions:




The most obvious reason behind divestiture is thought to be poor performance of that
business
Surprisingly, research found that companies that were more liquid were more likely to
be divested
In a liquid market, sellers will have a better opportunity to receive the full value, if not
an even higher value, for their asset than in markets that are less liquid.
When firms want to divest, those that can sell in liquid markets will be more likely to do
so, but those that face less liquid market may hold on to a non-profitable unit until
market liquidity improves
Round-Trip Wealth Effects:



When a company announces an acquisition, in many cases the market response is
negative. Research indicates that when a company announces a sell-off, perhaps a prior
acquisition, the market response is often positive. This raises the question: What is the
net, round-trip effect?
Results really did not indicate a positive or negative effect—mainly a neutral response.
While they did find negative effects for acquisitions and positive ones for sell-offs, the
combined effects were not statistically significant
There was, however, an interesting exception. When the target was a research and
development (R&D)–intensive business, and where there is evidence that the parent
may have supplied capital to fuel the target’s R&D needs, the net effect was positive.
Wealth effect of sell-offs:





A major motivating factor for divestitures and spinoffs is the belief that reverse synergy
may exist
Divestitures, spinoffs, and equity carve-outs are basically a downsizing of the parent firm
Therefore, the smaller firm must be economically more viable by itself than as a part of
its parent company
Spinoffs are a unique opportunity to analyze the effects of the separation
The research in the field of sell-offs presents a picture of clear benefits for shareholders
Price Effects of Voluntary Sell-Offs:
1. Effects of Sellers
 The equity market clearly concludes that the voluntary selling of a division is a
positive development will result in an increase in the value of the firm’s stock.
 If a company is selling a unit, it often maybe because it is no longer a good
strategic fit
 Perhaps it was a diversification acquired in a prior acquisition or the company
was a drain on the overall performance of the business.
 One of the benefits of sell-offs is to enable the seller to be more focused in areas
it excels in.
2. Effects of buyers:
 While the market is often not keen on acquisitions, it is more positive when it is
to acquiring a unit of another company
 For the buyer, this may be a good complementary fit and an extension of a
business in which it had already some success. In such instances, it would be
reasonable to have a positive market response for the seller and the buyer.
Corporate governance and sell-offs:





Managers may be reluctant to sell off a unit, especially if they played a role in its
acquisition. The sell-off ends up being an admission of a mistake, which is something
that many managers are reluctant to do.
It was found in research that divestitures created wealth. However, the research was to
determine the role that corporate governance played in the divestiture decision and the
magnitude of the positive wealth effect.
It was found in research that companies with more independent boards and large blockholders had greater positive shareholder wealth effects
Their research implies that the decision to divest needs more than the obvious
recognition of poor performance on a unit within the overall company
It seems that management often needs some pressure from independent directors and
large equity holders to be sufficiently motivated to “do the right thing.”
Managerial ownership and sell-off gains:
 Many companies have used various incentives to try to deal with the agency problems
and align the interests of management and shareholders
 One of the main compensation tools is stock options that make managers also owners.
This does not eliminate the agency problems, as managers still may get the bulk of their
compensation from non-equity-based sources, such as salary and perks
 Research found that not only did sellers enjoy positive shareholder wealth effects but
also these effects were positively related to the equity ownership of managers and
directors
 When managers and directors are playing with their own money, they are less likely to
hang on to losers
Spin-offs: A spinoff is the creation of an independent company through the sale or distribution
of new shares of an existing business or division of a parent company.
 A spinoff is a type of divestiture. It is an alternative to an outright divestiture, where the
company sells the unit and receives cash or other consideration.
 The spun-off companies are expected to be worth more as independent entities than as
parts of a larger business.
 The spun-off entity becomes a separate business that is independent of the parent
company. Shareholders of the parent are also shareholders of the spun-off business, but
the two companies usually operate independently.
 There is a pro rata distribution to the parent company’s shareholders, which is usually
done through a dividend. Because the spinoff is done through the payment of a
dividend, the courts usually regard dividend payments as part of the normal
responsibilities of the board of directors; thus, shareholder approval is usually not
required unless the amount of assets being spun off is substantially the bulk of the
company’s assets.
 In a sponsored spinoff, an outside party acquires an interest in the spun-off entity.
Often, this is done by giving the sponsor an incentive in the form of a discount on the
price of the shares.
 The debt of the overall company is allocated between the remaining parent company
and the spun-off entity. Usually, this is done in relation to the respective posttransaction sizes of the respective businesses.
Reasons for Spin-offs
1. To focus on a Division with Long Term Prospect
2. Different Strategic Priority
Tax Treatment of Spinoffs
One of the major advantages of a spinoff over an outright divestiture is that the spinoff may
qualify for tax-free treatment. This can be done if the transaction meets certain Internal
Revenue Code requirements (Sections 354 and 355). Among the requirements to qualify for
tax-free treatment is that
i) The parent company must own at least 80% of the shares of the unit being spun off.
ii) In addition, the parent company must not have acquired control of the unit less than
five years ago.
iii) The transactions must also satisfy the business purpose test. That is, it should not be
done only as a means of avoiding taxes.
Shareholder Wealth Effects of Spinoffs:


The market likes spinoffs. These transactions accomplish many of the same objectives of
divestitures but without the possible adverse tax effects.
Spinoffs prime benefit is tax advantage
Why spinoff according to activists?
 It can be more difficult to sell the overall company if that company includes some
unattractive parts.
 Spin- off is a kind of solution in the eye of activists for less marketable businesses
 After a spinoff, the spun-off entity may be more of a pure play.
 With a more focused business, it may be easier to find strategic buyers for the business.
If this can be done, the sellers may be able to realize a premium on the marketable part
of the business, thus releasing value to investors.
Spinoff versus Sell-Off Decision:
Spinoffs and Bondholder Wealth:
Q: Are positive market responses for shareholders coming at the expense of bondholders?
 Early research failed to find evidence of such wealth transfers
 Maxwell and Rao found that bondholders suffered a negative abnormal return of 88
basis points in the month of the spinoff announcement over the period 1976-1997.
 Factors such as the loss of collateral value and bankruptcy protection from the spun-off
assets seem to be a good explanation for this response.
 Companies would have their bond rating downgraded in the month of the spinoff
 The higher the shareholder gain, the greater was the loss to bondholders.
 However, the positive impact on shareholders and firm value is only partially explained
by a wealth transfer from bondholders.
Wealth Effects of Voluntary Defensive Sell-offs
 There is some evidence that when these voluntary sell-offs are used as an
antitakeover defense, positive effects may not exist.
 These results suggest that when firms engage in sell-offs to prevent themselves
from being taken over, the market treats the transactions differently and does
not consider it a positive change.
Wealth Effects of Involuntary Sell-offs
 Studies show in case of involuntary sell-off price stock decline before the formal
filing of the complaint.
 The finance research community seems to have reached a consensus that a
divestiture that is forced by government mandate, as opposed to a voluntary
sell-off, will have an adverse effect on the divesting firm’s stock price.
 However, this downward movement generally ends with the spin-off, after
which the stock price rebounds.
Corporate Focus and Spinoffs
 One of the benefits a company can derive through a sell-off is to become more focused.
This is particularly true for companies that have become diversified and suffer from
having their shares trade at the diversification discount.
 However, while many of the studies use spinoffs to demonstrate focus-related benefits,
they also apply to other types of sell-offs, such as divestitures or equity carve-outs.
 Studies found improvements in various measures of performance, such as the return on
assets, for cross-industry spinoffs but not for own-industry deals. They conclude that
cross-industry spinoffs create value only when they result in an increase in corporate
focus. They attribute the performance improvements to companies removing unrelated
businesses, allowing managers to concentrate their efforts on the core business, and
removing the distraction of noncore entities.
Equity carve-outs: Through the process of an Equity Carve-Out, a company tactically separates
a subsidiary from its parent as a standalone company. The new organization is complete with its
own board of directors and financial statements. The parent company usually retains its
controlling interest in the new company. It also offers strategic support and resources to help
the new business succeed.
The carve-out is not about selling the business unit outright but, instead, is selling a portion of
the equity stake of that business. This helps the parent organization to retain its hold over the
subsidiary by keeping the majority equity for itself. The Equity Carve-Out allows a company to
strategically diversify into some other businesses which may not be its core operation.
 An equity carve-out is a public offering of a partial interest in a wholly owned subsidiary,
although the seller could, theoretically, sell as much as the entire 100% in the offering.
 Usually, however, that is not the case and only a partial interest is sold. Most of the
time, the seller retains control of the unit, although the carve-out may be the first step
in selling off the entire business.
 However, the parent company usually retains a controlling interest in the new company
and offers strategic support and resources to help the business succeed.
 It is basically a variation of a divestiture that involves the sale of an equity interest in a
subsidiary to outsiders.
 The sale may not necessarily leave the parent company in control of the subsidiary. The
new equity gives the investors shares of ownership in the portion of the selling company
that is being divested.
 The parent retains the right to do a tax-free spinoff in the future. Often a two-step
transaction and linked to some subsequent events. Enables the parent to “test the
waters” for the market’s appetite for the unit’s shares. If this does not look promising, it
may simply require the unit’s shares and thus, cancelling the “sale.”
Characteristics of Equity Carve-Out Firms:
Post Carve-Out Performance
 The carved-out companies’ financial performance, as measured by return on
assets, peaked at issue and then subsequently declined.
 The parent companies had fairly consistent performance and did not decline
after the carve-out.
Disposition of the Carve-out proceeds
 The market’s reaction to the carve-outs depended on what the company used
the funds for.
Equity Carve-Outs versus Public Offerings
Available information
 In carve-out, the annual reports and other publicly available documents may be
very brief and yield little of the data necessary to value the components of a
company.
 In public offerings, the company publishes more detailed information about its
operations.
Equity Carve-Outs versus Spinoffs
Cash Inflow
 In a spin-off, the parent company distributes shares of the subsidiary that is
being spun-off. So, the parent company typically receives no cash consideration
for the spin-off.
 In a carve-out, the parent company sells some or all of the shares in its subsidiary
and unlike a spin-off, the parent company generally receives a cash inflow
through a carve-out.
Involved shareholders
 In spin-off, shares are distributed among the existing shareholders on a pro rata
basis in the form of special dividend.
 In a carve-out, the parent company sells some or all of the shares in its subsidiary
to the public through an initial public offering (IPO).
Controlling interest
 In a spin-off, the controlling interest of the parent company on the subsidiary
becomes zero.
 In a carve-out, the controlling interest of the parent company reduces but still
they are the majority in the subsidiary.
Voluntary liquidations:
 Voluntary liquidations, or bust-ups, are the most extreme form of corporate
restructuring.
 Voluntary liquidation is a self-imposed wind up and dissolution of a company that has
been approved by shareholders
 Two types of voluntary liquidation:
I. Creditor’s voluntary liquidation: for insolvent companies.
Company’s directors voluntarily choose to end the company’s trading and liquidate its
assets in order to pay its creditors
A CVL gives both the company and its creditors more space to end the company while
avoiding allegations of fraudulent or wrongful trading.
II.
Member’s voluntary liquidation: for the solvent companies.
One of the most common is to transfer assets from the company to its shareholders
without facing a significant tax burden.
A Members Voluntary Liquidation might be used as a tool to re-organize a group of
companies
Reasons behind voluntary liquidation:
1. Termination of company's operations
2. Winding up financial affairs
3. Dismantling its corporate structure
4. Paying back creditors according to their assigned priority.
Tracking stocks: A tracking stock is a special equity offering issued by a parent company that
tracks the financial performance of a particular segment or division but which does not confer
ownership in the company or the division.
 In the 1990s, companies began to issue tracking stocks as alternatives to sell-offs.
 It is issued by a parent company and tracks the financial performance of a particular
segment or division.
 When a parent company issues a tracking stock, all revenues and expenses of the
applicable division are separated from the parent company's financial statements
 Tracking stock has limited or no voting rights





The reason for issuing tracking stock is to separate a high-growth division from a larger
parent company
The parent company and its shareholders remain in control of the subsidiary's or unit's
operations.
It also is sometimes called letter stock or alphabet stock. Sometimes when a company
acquires other firms but the market prices of the combined entity sell at a discount, the
company may try to boost the stock by allowing one or more divisions to trade
separately as tracking stocks.
After the issuance of the tracking stock, the parent company still has legal control of the
assets and the division and is a consolidated entity. The parent has the voting rights of
the tracking shares.
One of the major differences between tracking stocks and sell-offs is that a separate
legal entity is created in a sell-off. With a tracking stock, the shareholder has a legal
interest in the earnings of a division
Example: Tracking stocks were first created in 1984, when General Motors (GM) acquired
Electronic Data Systems (EDS). Ross Perot, the colorful CEO of EDS, was concerned that
employees, who owned significant shareholdings in the company, would be less motivated if
they received shares in slow-growth GM in exchange for their fast-growing shares in EDS. As a
solution, they issued Class E shares, which tracked the performance of the EDS division of GM.
General Motors also used this mechanism in 1985 when it issued Class H shares, which followed
the performance of its Hughes Aircraft division.
A Master Limited Partnership (MLP) is a limited partnership that is publicly traded.
 It combines the tax benefits of a partnership – profits are taxed only when investors
receive distributions – with the liquidity of a public company. The key advantage of the
MLP is its elimination of the corporate layer of taxation.
 Corporations have used MLPs to redistribute assets so that their returns are not subject
to double taxation. In a rollout MLP, corporations may transfer assets or divisions in
separate MLPs.
 Limited partners: Are the investors who purchase shares in the MLP and provide the
capital for the entity's operations. They receive periodic distributions from the MLP,
usually on a quarterly basis.
 General partners: Are the owners who are responsible for managing the day-to-day
operations of the MLP. They receive compensation based on the partnership's business
performance.
Corporate Split-Ups: A split-up is a corporate action in which a single company splits into two
or more separately run companies.
Example: In October 2015, The Hewlett-Packard Company completed a split-up that resulted in
the official formation of two new entities, HP Inc. and Hewlett-Packard Enterprises. With the
split-up, shareholders of the original company were able to choose which entity they wished to
remain invested in.
It can be much more beneficial to shareholders to split up the company so that each segment
can be managed independently to maximize profits. The government can also force the splitting
up of a company, usually due to concerns over monopolistic practices.
A split-off is a method of reorganizing an existing corporate structure where shares of a
business division, subsidiary or newly affiliated company are transferred to stockholders in
exchange for stocks of the parent company.
 A split-off is a corporate reorganization method in which a parent company divests a
business unit using specific structured terms. In a split-off, the parent company offers
shareholders the option to keep their current shares or exchange them for shares of the
divesting company.
 In a split-off, shareholders in the parent company are offered shares in a subsidiary, but
the catch is that they have to choose between holding shares of the subsidiary or the
parent company. A shareholder has two choices: (a) continue holding shares in the
parent company or (b) exchange some or all of the shares held in the parent company
for shares in the subsidiary. Because shareholders in the parent company can choose
whether or not to participate in the split-off, distribution of the subsidiary shares is not
pro rata as it is in the case of a spin-off.