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- - - - - - - - Chapter 12 - - - - - - - -. Restructuring Organization and Ownership Relationships. Spin-Offs. Company owns or creates a subsidiary whose shares are distributed on a pro rata basis to shareholders of parent company Subsidiary becomes publicly owned corporation.

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chapter 12

- - - - - - - - Chapter 12- - - - - - - -

Restructuring Organization and Ownership Relationships

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 1

spin offs
Spin-Offs
  • Company owns or creates a subsidiary whose shares are distributed on a pro rata basis to shareholders of parent company
  • Subsidiary becomes publicly owned corporation

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 2

slide3
Parent company often will retain from 10% to under 20% of shares of the new subsidiary
  • Spin-off often follows the initial sale of up to 20% of the shares in an initial public offering (IPO) — transaction known as an equity carve-out

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 3

slide4
Event return studies of spin-offs
    • Significant positive 3-5% abnormal return to parent shareholders
    • Size of announcement effect positively related to size of spin-off
    • Spin-offs to avoid regulation experienced abnormal returns of 5-6% as compared to 2-3% for the remainder of the sample
    • No adverse effect on bondholders

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 4

slide5
Tax effects
    • No positive abnormal returns for taxable spin-offs
    • Positive abnormal returns for nontaxable
    • Controlling for size, tax effects disappear
  • Both spin-offs and their parents are more frequently involved in subsequent takeovers
    • Firms which engage in no further restructuring activity earn only normal returns
    • Firms which engage in subsequent takeovers account for positive abnormal returns

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 5

slide6
Performance studies of spin-offs
    • Bregman
      • Annualized returns were 31.8%, 18 points better than S&P 500
    • Karen and Eric Wruck
      • Spin-offs outperformed overall stock market
      • Few spectacular performances dominated results
    • Forbes study
      • Combined stock performance of parent and spin-off
        • 40% did better than S&P 500
        • 60% underperformed

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 6

slide7
Anslinger, Klepper, and Subramaniam (1999)
    • Sample of 12 spin-offs achieved returns over a two-year period of 26.9% compared to 17.2% for the S&P 500
    • 8 spin-offs underpeformed index
  • Mixed results may reflect characteristics of industries
  • Firms in industries with excess capacity or low sales growth underperform broader indexes
  • Results should be related to industry peers

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 7

slide8
Tax aspects of spin-offs
    • Spin-off qualify for tax-exempt status if parent company own 80% of voting subsidiary stock
    • Spin-off transactions
      • Companies spin off with two classes of stock
        • Parent sells nonvoting class of stock in public offering and then spins off voting stock tax free
        • Parent can do an equity carve-out of 20% of the voting stock, spin off remainder and entire spin-off transaction is tax free

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 8

slide9
Companies create new subsidiary
    • Parent company creates subsidiary
    • Subsidiary has two classes of shares: Class A non-voting, Class B voting
    • Parent company owns all B shares
    • Parent company distribute A shares to its shareholders
    • Parent company may have option to buy back proportion of subsidiary's stock it does not now own
    • Parent company is not required to buy back shares or to put more money into subsidiary
    • Creation of subsidiary allows parent to separate risk of subsidiary business from its core operations — shareholders decide whether to increase or decrease their own risk

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 9

equity carve outs
Equity Carve-Outs
  • Equity carve-out is an IPO of some portion of the common stock of a wholly owned subsidiary
  • Also referred as "split-off IPOs"
  • Resembles seasoned equity offering of the parent in that cash is received from a public sale of equity

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 10

slide11
Other changes when subsidiary equity is "carved out"
    • IPO of common stock of subsidiary initiates public trading in a new and distinct set of equity claims on assets of subsidiary
    • Management system for operating the assets is likely to be restructured
    • Public market value for operations of subsidiary becomes established
    • Financial reports are issued on the subsidiary operations

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 11

slide12
Equity carve-outs can be used by a firm to raise equity funds directly related to the operation of a particular segment or industry
  • Equity carve-outs also used as first step in spin-off and split-ups

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 12

slide13
Comparison to spin-off
    • Similar to voluntary spin-off in that it results in subsidiary's equity claims traded separately from the equity claims on the parent entity
    • Differences
      • In spin-off a distribution is made pro rata to shareholders of parent firm as dividend; in equity-carve-out, stock of subsidiary is sold in public markets for cash which is received by parent
      • In spin-off, parent firm no longer has control over subsidiary assets; in carve-out, parent generally sells only minority interest in subsidiary and maintains control over subsidiary assets and operations

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 13

slide14
Comparison to divestitures
    • Similar in that cash is received
    • Differences
      • Divestiture is usually to another company
      • Control over assets sold is relinquished by parent-seller and trading of subsidiary is not initiated

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 14

slide15
Transaction examples
    • GM-Delphi
      • In August 1998, the GM board of directors voted to separate Delphi from GM
      • In February 1999, Delphi completed its IPO of 100,000,000 shares of common (17.7% equity carve-out) while GM held remaining 465,000,000 (82.3%) of Delphi's outstanding stock
      • In April 1999, board of directors approved spin-off of 452,565,000 of GM's Delphi shares through a dividend of 0.7 shares of Delphi for one share of GM common stock
      • Remaining 12,435,000 of GM's shares were contributed to the General Motors Welfare Benefit Trust
      • Delphi became a fully independent, publicly traded company (split-up) after the spin-off

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 15

slide16
DuPont-Conoco
    • DuPont bought Conoco in 1981
    • On May 12, 1998, DuPont announced it would divest itself of 20% of its Conoco oil subsidiary and subsequently spin-off remainder
    • In initial IPO, DuPont sold 150 million A shares which carried one vote
    • Spin-off of remainder of Conoco was accomplished by a share exchange in which for each share of DuPont stock, holder could receive 2.95 shares of class B stock of Conoco
    • Class B stock was identical to class A stock except that each share carried 5 votes
    • GM paid Delphi's shares as a dividend; to obtain Conoco shares, DuPont shareholders had to exchange their DuPont shares
    • Share exchange method allowed DuPont's shareholders to choose whether they wanted to invest in the chemical industry versus petroleum industry

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 16

slide17
Carve-out event returns
    • Market reaction not easily predictable since equity carve-outs have characteristics in common with spin-offs, divestitures, and seasoned equity issues
      • Spin-offs — abnormal returns to parent firm of 2- 3% on average
      • Divestitures — gains to selling firm of 1-2% on average
      • Seasoned equity issues — negative residuals of 2-3% on announcement
    • Event returns +2 - +5%

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 17

slide18
Performance studies of carve-outs
    • Vijh (1999)
      • Compared performance of carve-outs to several benchmarks — carve-outs did not underperform benchmarks
      • Carve-outs earned an annual raw return of 14.3% during first three years — contrast to poor performance of IPOs which have annual return of 3.4%
      • Average initial listing-day returns for carve-outs of 6.2%, with median of 2.5% — much smaller than 15.4% for IPOs

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 18

slide19
Possible performance explanations
      • Parent firms tend to be relatively unfocused — carve-outs are an opportunity to improve focus
      • Subsidiaries gain partial freedom to pursue own activities
  • Allen (1998)
    • Examined performance of equity carve-outs at Thermo Electron
    • Thermo Electron has performed well since program implementation
      • $100 invested in firm in 1983 would have appreciated to $1,667 by end of 1995
      • Contrast to industry index which grew to $524, and S&P 500 which grew to $381

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 19

tracking stock
Tracking Stock
  • Tracking stocks are separate classes of common stock of parent corporation
  • First issued in 1984 by GM in connection with its acquisition of EDS
  • Also known as letter stock, targeted stock, and designer stocks

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 20

slide21
Company's business operations are split into two or more common equity claims, but businesses remain as wholly owned segments of single parent
  • Each tracking stock is regarded as common stock of consolidated company and not of subsidiary
  • Tracking stock company is usually assigned its own distinctive name

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 21

slide22
Tracking stock trades separately from parent company so that dividends paid to shareholders can be based on cash flows of tracking company alone
  • Compensation of tracking company's managers can be based on financial results and stock price of tracking stock
  • 80% of firms issuing tracking stocks use a dividend process but some firms use the issuance of tracking stock as a source of cash

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 22

slide23
Comparison to dual-class stock and spin-offs
    • Dual-class stocks
      • In dual-class stocks, class A generally has one vote per share versus five or more per share for class B, but class A has higher allocations of dividends
      • Tracking stock has same voting rights as shareholders who hold stock in parent

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23

slide24
Spin-off
    • Similar to spin-off in that financial results of parent and subsidiary are reported separately
    • Different in that spin-off is a separate entity with its own board of directors and shareholders who can vote for board of their separate company but not for the parent
    • In spin-off, initial assignment of assets and other relationships are defined, thereafter they are independent entities
    • In tracking stock, board of parent continues to control activities of tracking segment

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24

slide25
Benefits and limitations
    • Benefits
      • Tax-free issuance
      • Financial markets can value different businesses based on their own performance
      • Analysts' coverage likely to be improved
      • Stock-based management incentive programs can be related to each tracking business unit
      • Investors are provided with quasi-pure play opportunities
      • Increase flexibility in raising equity capital
      • Provides alternative types of acquisition currency

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 25

slide26
Limitations
    • Tracking stock subsidiary is generally subject to will of parent
    • Potential conflict of interest over cost allocations or other internal transfer transactions
    • Tracking stock subsidiary may command less takeover interest because of blurred relationship with parent

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 26

slide27
Price performance
    • Main determinant is economic characteristics of businesses in which tracking stock subsidiary have been established
    • Combined parent/tracking stock performance has been, with exceptions, superior to performance of their peer groups

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 27

split ups
Split-Ups
  • Companies split into two or more parts
  • Accomplished usually by initial carve-outs, followed by spin-offs of individual parts

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 28

slide29
Examples
    • Hewlett-Packard and Agilent
      • Bring more focus
      • Avoid overlap of capabilities
    • AT&T restructuring
      • Avoid conflicts from AT&T’s role as supplier and competitor in long distance business
      • Improve valuation multiples for core business
    • ITT Corp
      • Attempt to improve share price
      • Separate poor performers
      • Resulted in takeover

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 29

rationale for gains to sell offs and split ups
Rationale for Gains to Sell-Offs and Split-Ups
  • Information
    • Subsidiary true value hidden
    • Preference for pure-play (single-industry) securities
    • Increased availability of information

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 30

slide31
Managerial efficiency
    • Management's inability to manage complex organizations
    • Sell-offs sharpen focus, get rid of poor fit subsidiaries, eliminate negative synergy

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 31

slide32
Management incentives
    • Bureaucracy and consolidation of financial statements stifle entrepreneurial spirit — hide good (bad) performance
    • Conflict of objectives between parent and subsidiary
    • Tie compensation directly to subsidiary performance

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 32

slide33
Tax and/or regulatory factors
    • Subsample of spin-offs citing tax benefits have higher abnormal returns
    • Tax motives — subsidiaries can take forms that shelter income
    • Regulatory motives — spin-offs can free parent from regulatory scrutiny

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 33

slide34
Bondholder expropriation
    • Spin-off reduces bondholder collateral
    • Unsupported by evidence
      • Bondholders can anticipate spin-offs and write protective covenants
      • Subsidiaries have their own debt or take on a pro rata share of parent debt
      • Bondholders may benefit if junior debt of parent becomes senior debt of subsidiary
      • No evidence of bond price or ratings decline at spin-off announcements

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 34

slide35
Changing economic environment
    • Major shifts in economic environment alter parent and subsidiary opportunity sets such that separate operations become optimal
  • Avoiding conflicts with customers
    • Spin-off can deal more effectively with customers
    • Spin-off can avoid conflict if customer is a competitor of parent firm

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 35

slide36
Provide investors with pure winners
    • Separate segments that lower valuation multiple on overall company
  • Option creation
    • Common stock is an option on underlying technology of firm
    • Spin-off creates two options on same assets, therefore more value

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 36

slide37
Increase market spanning
    • Expanded opportunity sets to appeal to different investor clienteles
    • Improve completeness of markets — increased number of securities for given number of possible states of the world
  • Enable more focused mergers
    • Facilitate more focused mergers where bidder is interested in only a subset of target assets

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 37

the choice of restructuring methods
The Choice of Restructuring Methods
  • Spin-offs
    • Parent's potential position to create value through skills, systems, or synergies is weak
    • Parents and subsidiaries have conflicts of interest

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 38

slide39
Equity carve-outs
    • Firms can easily separate subsidiaries
    • Bring added attention to subsidiaries with high margins and growth
    • Provide capital for acquisitions or other investments
    • Allow division managers to take primary responsibility for financing and investment decisions

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 39

slide40
Subsidiaries may have better access to capital
    • Take advantage of parent's debt rating
    • Seek funding from capital markets instead of overstating budgeting needs to parent
  • Fund projects that otherwise would depress parent's earnings

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 40

slide41
Tracking stocks
    • Provide capital for acquisition or other investment programs
    • Bring attention to subsidiaries with high growth or margins
    • Subsidiaries can take advantage of capital structure of parent
    • Reduce taxes — net operating losses of parent or subsidiary can be used to reduce overall corporate taxes
    • Useful for firms with divisions that share significant synergies so full separation not desirable

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 41

slide42
Limitations
    • Parent still controls
    • Potential conflicts of interest with parent
    • Value depends on its performance

©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 42