Sell offs, spin offs, carve outs
and tracking stock
Corporate Restructuring
Tim Thompson
© Timothy A. Thompson, 2007
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Defining divestitures

Selling assets, divisions, subsidiaries to
another corporation or combination of
corporations or individuals
© Timothy A. Thompson, 2007
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Divestitures
Company A without Subsidiary B
Subsidiary B
Company C
© Timothy A. Thompson, 2007
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Divestitures (2)
Company A w/o subsidiary B
Cash, securities or assets as
consideration
Old Sub B
Company C
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Features of divestitures
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Selling corporation typically receives
consideration for the assets sold
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cash
securities
other assets
Divestitures are typically taxable events
for selling corporation (new basis for
purchaser)
© Timothy A. Thompson, 2007
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Spin offs
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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
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as long as it jumps through substantial
hoops
© Timothy A. Thompson, 2007
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Spin offs
Company A without Subsidiary B
Subsidiary B
Shareholders own shares of combined company. Own the equity in subsidiary implicitly.
© Timothy A. Thompson, 2007
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Spin offs (2)
Company A after spinoff
Shareholders receive
Shares of company B
New company B
Old shareholders still own shares of company A, which now only represent ownership of A without B.
© Timothy A. Thompson, 2007
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Equity carve outs
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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.
© Timothy A. Thompson, 2007
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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.
© Timothy A. Thompson, 2007
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Equity carve out (partial IPO)
Company A without subsidieary B
Portion of
Sub B equity
Not sold
X % of sub B equity 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
© Timothy A. Thompson, 2007
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Motivations for transactions
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Market for corporate control
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Asset are more valuable to alternative management team
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Unlocking hidden value
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Stock market problem or management problem?
Improving management incentives
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Divestiture, spin off, carve out, tracking stock
Divestiture, spin off, carve out, tracking stock
Agency costs
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Divestiture, spin off, carve out, tracking stock
© Timothy A. Thompson, 2007
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Moving assets to more highly
valued user
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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
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Or the threat may improve incentives
© Timothy A. Thompson, 2007
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Focus management
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Part of undiversification
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Superior performance measurement
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Easier to run, more able to focus efforts
Because you can use direct equity for
compensation (divestiture?)
By the stock market?
Reduction in bureaucracy/Decision making
authority
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Internal capital markets/external cap markets
© Timothy A. Thompson, 2007
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Unlocking hidden value
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Creation of pure play
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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!
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Internet subs in 1998-99
Biotech
Gold subs/Japanese subs in late ’80’s
© Timothy A. Thompson, 2007
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Other reasons
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Reduction in agency costs
Tax/regulatory factors
Bondholder wealth expropriation
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Divestitures
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Stock price reaction to sell off
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Statistically positive response (Table
10.5 in Gaughn), but small
Pre-sell off performance is contradictory
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Good performance, may be leakage
Poor performance, may be reason for
restructuring
Post-sell off performance of parent
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Contradictory (Jain vs. Klein in Kaiser)
© Timothy A. Thompson, 2007
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Motives for divestiture
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Kaplan and Weisbach
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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)
© Timothy A. Thompson, 2007
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Defensive divestitures
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Company is worried about being taken over
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sells “crown jewels” so they’re not attractive
anymore
does an leveraged recap and sells the dogs
More generally, divestitures follow leveraged
acquisitions
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pay down debt and restructure company to be
most valuable going-forward
© Timothy A. Thompson, 2007
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Divestitures: government
requirements
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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
© Timothy A. Thompson, 2007
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Divesting business unit to
managers
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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?
© Timothy A. Thompson, 2007
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Divestiture vs. other
restructuring
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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
© Timothy A. Thompson, 2007
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Bad bidders become good
targets?
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Kaplan and Weisbach
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271 large acquisitions completed 1971-1982
44% divested by 1982
Diversification acquisitions four times more
likely to be divested
Mitchell and Lehn
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Companies with “negative” responses to acquisitions
tend to divest more frequently
Become takeover targets more frequently
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Analysis
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Is division worth more to you or to
buyer?
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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?
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Buyers of acquired units
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In contrast to acquirers of public
companies
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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.
© Timothy A. Thompson, 2007
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Spin offs
© Timothy A. Thompson, 2007
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Central features of spin offs
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Spin offs are a distribution of subsidiary
shares to parent company shareholders
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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
© Timothy A. Thompson, 2007
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Requirements for Tax-free Distributions
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Section 355 of IRC, “Distributions of stock and securities of a
controlled corporation”
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“transaction not used principally as device for distribution of earnings and
profit…,” I.e. a valid business purpose
active business requirement is met
Parent must control and must distribute control*
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80% of control, not nec. 80% of market value
Continuity of interest and control requirement
Sub cannot have been acquired in last five years by parent in taxable
transaction
Divesting parent or spun-off sub cannot be acquired within two years of
spin off, or spin off loses tax free status
© Timothy A. Thompson, 2007
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IRS Guidelines for Spinoffs
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Generally acceptable business purposes:
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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
© Timothy A. Thompson, 2007
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What if the spin off is taxable?
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Corporate level
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Shareholder level
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Parent corporation recognizes a gain equal to the difference
between the fair market value of property distributed less the
parent’s tax basis in the net assets of the divested sub
Can be very large or small, depending on the size of the gain
Dividend taxable at ordinary rates, equal to the fair market value of
the property received, that is, the fair market value of the spun off
sub
Spin offs that fail to qualify are generally, cancelled
© Timothy A. Thompson, 2007
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What’s a Morris trust?
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Essentially it was a way to turn a taxable divestiture into a tax
free spin off with a subsequent tax free merger
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Spin off assets you want to keep to your shareholders in tax free
spin off
Remaining assets are a sub you wanted to divest
Acquirer buys the remaining assets in tax free merger and avoided
taxable aspect of divestiture
Two-year no acquisition of parent intended to eliminate the
“Monetizing Morris Trust” transaction
© Timothy A. Thompson, 2007
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Spin off as takeover defense
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Hostile suitor
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Spin off a division with highly appreciated
assets
Acquirer buys parent triggers prior spin off
to be taxable
Tax “poison pill”
ITT threatened this in battle with Hilton
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Spin offs in 1990’s
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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
© Timothy A. Thompson, 2007
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Spin off studies
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Older studies (Kaiser)
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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
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Post spinoff positive performance both for parent and
subsidiary
Both more active in takeovers
© Timothy A. Thompson, 2007
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Spun off entity performance
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On average, very good performance
Just correcting for value losses from
earlier acquisitions?
Not all spun off companies are stars
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3M/Imation
Interco/Converse & Florsheim
Allen Group/TransPro Inc.
Ralston Purina/Ralcorp Holdings
© Timothy A. Thompson, 2007
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Some recent spin offs
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Pepsi/Tricon
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Whitman Corporation/Hussman/Midas
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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)
Conglomerate discount, conflicts among management of
divisions
No synergies between bottlers/heavy industry/auto service
RJR/Nabisco Holdings
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Tobacco litigation, discounting food company
Carl Icahn, Bennet Lebow
© Timothy A. Thompson, 2007
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How can spin offs generate
money for parent?
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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
© Timothy A. Thompson, 2007
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Variants of spin offs
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Split offs
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Divesting parent corporation distributes
stock in sub to its shareholders in
exchange for some of their parent stock
Exchange may or may not be pro rata
May avoid 355 entirely
© Timothy A. Thompson, 2007
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Limited split off Abercrombie
and Fitch
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Dutch auction
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Limited’s shareholders specify an exchange ratio, within a
range, under which they would exchange a share of Limited
for a fraction of a A&F share (.73-.86)
After tabulation, Limited finds the ratio for which they can
distribute 90% of A&F stock, probably won’t be prorata
Exchanging shareholders probably get a premium, with no
tax
Benefits
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Shareholders can rearrange holdings in parent tax free
Also, because the split off effects a buyback, there is less
EPS dilution than a spin off
© Timothy A. Thompson, 2007
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Equity Carve Outs
© Timothy A. Thompson, 2007
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Tax treatment of carve outs
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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?
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Avon Japan (1987), USG?
© Timothy A. Thompson, 2007
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Carve outs
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Why sell a partial stake?
Pure play
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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
© Timothy A. Thompson, 2007
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Other motives for carve outs
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Divisional managers incentives
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Kraft/Phillip Morris
Thermo Electron
Sell “hot” properties
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Gold subs in mid ’80’s
Japanese subs in late ’80’s
Internet subs in ’97-’99
Why not sell all of it?
© Timothy A. Thompson, 2007
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Targeted stock
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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.
© Timothy A. Thompson, 2007
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Target stock vs. spin off
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Spin off creates equity of subsidiary, but
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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
© Timothy A. Thompson, 2007
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Target stock vs. carve out
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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
© Timothy A. Thompson, 2007
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Target stock is not stock of the
targeted business
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Target stock is stock of the consolidated
company, not the targeted business (sub)
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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
© Timothy A. Thompson, 2007
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Features of target stock
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Reduces, but does not eliminate, crosssubsidization 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
© Timothy A. Thompson, 2007
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Features of target common
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Features in each target share have to
be decided:
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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
© Timothy A. Thompson, 2007
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Distribution of target shares
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Pro rata stock dividend paid to existing
holders
Sell target shares to new public investors,
with remainder held by parent
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proceeds retained by sub
proceeds allocated elsewhere in company
Shares issued in acquisition of target
company
© Timothy A. Thompson, 2007
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Cash flow rights
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Dividend policy subject to discretion of
board
“Available dividend amount” =
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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
© Timothy A. Thompson, 2007
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Voting rights
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Floating voting rights
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proportional to market value of underlying
business
Asset disposition and liquidation rights
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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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