FIN 502: Corporate Restructuring

Week-9

Alternative Business and

Restructuring Strategies
Learning Objectives

Primary Learning Objective: To provide

students with an understanding of alternative
exit and restructuring strategies.
Secondary Learning Objectives: To provide
students with an understanding of
– Divestiture, spin-off, split-up, equity carve-
out, split-off, and tracking stock strategies
– Criteria for choosing strategy for viable firms
– Options for failing firms
Divestitures
Sale of a portion of the firm to an outside party generally
resulting in a cash infusion to the parent. Most common
restructuring strategy.
Motives:
– De-conglomeration / increasing corporate focus
– Moving away from the core business
– Assets are worth more to the buyer than to the seller
– Satisfying government requirements
– Correcting past mistakes
– Assets have been interfering with profitable operation
of other businesses
 Deciding When to Sell: Financial
Evaluation of Divestitures
1. Estimate unit’s after-tax cash flows viewed on a standalone basis, carefully
considering dependencies with other operating divisions
2. Determine appropriate discount rate
3. Calculate the unit’s PV to estimate enterprise value
4. Calculate the equity value of the unit as part of the parent by deducting the
market value of long-term liabilities
5. Decide to sell or retain the division by comparing the market value of the
division (step 3) minus its long-term liabilities (step 4) with the after-tax
proceeds from the sale of the division

Give examples of interdependencies that might exist among the operations

of a parent firm?
What is the appropriate discount rate for valuing a specific business unit
within a parent firm? (i.e., the parent’s cost of capital or the cost of capital
of the industry in which the business unit competes)
Divestiture Selling Process

Proceed to
Negotiated
Settlement

Public Sale or
Reactive Sale Auction

Pursue
Alternative
Bidders Private “One
on One” or
Controlled
Potential
Auction
Seller
Public Sale or
Auction

Proactive Sale
Private “One
on One” or
Controlled
Auction
 Public or Controlled Auctions

Sequence of events:
1. Qualified bidders sign nondisclosure / receive
prospectus
2. Submission of non-binding bids expressed as
range
3. Bids ranked by price, financing ability, form of
payment, form of acquisition; and ease of deal
4. Best and final offers
Choosing the Right Selling Process
Selling Process
One on One Negotiation (single bidder)
Public Auction (no limit on number of
bidders)
Controlled Auction (limited number of
carefully selected bidders)
Advantages/Disadvantages
Enables seller to select buyer with greatest
synergy
Minimizes disruptive due diligence
Limits potential for loss of proprietary
information to competitors
Most appropriate for small, private, or hard
to value firms
May discourage some bidders concerned
about excessive bidding by uninformed
bidders
Potentially disruptive due to multiple due
diligences
Sparks competition without disruptive
effects of public auctions
May exclude potentially attractive bidders
Spin-Offs

Spin-Offs: New legal subsidiary created by parent

with new subsidiary shares distributed to parent
shareholders on pro-rata basis (e.g., Medco by
Merck in 2004)
– Shareholder base in new company is same as
parent
– Subsidiary becomes a publicly traded company
– No cash infusion to parent
– Tax-free to shareholders if properly structured
 Spin-Offs

Stage 1: Parent board declares stock Stage 2: Parent has no remaining

dividend of subsidiary shares interest in subsidiary

Parent Parent Firm Parent Parent Firm

Firm Shareholders Firm Shareholders

Subsidiary Stock Parent Shareholders Subsidiary

Paid to Shareholders Own Both Parent & Independent
Subsidiary As Dividend Subsidiary Stock of Former
Parent

How might a spin-off create value for parent company shareholders?

 Kraft Foods Breaks Up
In 2010, Kraft acquired British confectionery company Cadbury for $19 billion. While the firm became the
world’s largest snack company with the takeover, it was still entrenched in its traditional business, groceries,
on the book’s at a low historical cost. The company now owned two very different product portfolios.
Between January 2010 and mid-2011, Kraft’s share price grew faster than the S&P 500; however, it
continued to trade at a lower price-to-earnings multiple than such competitors as Nestle and Groupe Danone.
Expressing concern that Kraft was not realizing the promised synergies from the Cadbury deal, activist
investors, Nelson Peltz’s and Bill Ackman, had discussions with Kraft’s management about splitting the
firm.
To avert a proxy fight, Kraft’s board announced on August 4, 2011, its intention to divide the firm into
two distinct businesses. The proposal entailed separating its faster-growing global snack food business from
its slower growing U.S. centered grocery business. The separation was completed through a spin-off to Kraft
Food shareholders of the grocery business on October 1, 2012. The split up was justified as a means on
increasing focus, providing greater opportunities, and of giving investors a choice between the faster growing
snack business and the slower growing but more predictable grocery operation.
Discussion Questions:
1. Speculate as to why Kraft chose not divest its grocery business and use the proceeds to either reinvest in
its faster growing snack business, to buy back its stock, or a combination of the two?
2. How might a spin-off create shareholder value for Kraft Foods’ shareholders?
3. There is often a natural tension between so-called activist investors interested in short-term profits and a
firm’s management interested in pursuing a longer-term vision. When is this tension helpful to shareholders
and when does it destroy shareholder value?
Equity Carve-outs

Two forms: Initial public offering (IPO) and subsidiary equity carve-out
IPOs represent the first offering of stock to the public of all or a portion of the
equity of a formerly privately held firm (e.g., UPS sells 9% of its shares in
1999) or a reorganized firm emerging from bankruptcy (e.g., GM in 2010)
– The cash may be retained by the parent or returned to shareholders
Subsidiary equity carve-out is a transaction in which the parent sells a portion
of the stock of a wholly-owned subsidiary to the public. (e.g., Phillip Morris’
2001 sale of 15% of its Kraft subsidiary)
– The cash may be invested in the subsidiary, retained by the parent, used to
pay off parent or subsidiary debt, or returned to the parent’s shareholders
– Although the parent generally sells less than 20% of the sub’s equity, the
sub’s shareholder base may be different than that of the parent

In addition to generating cash, what other motivations may a parent firm have in
undertaking an equity carve-out?
Equity Carve-Outs

Initial Public Offering Subsidiary Equity Carve-Out

Private Firm Sells Parent Firm Sells Cash Public/Private

A Portion of Its Equity A Portion of Its
Equity Markets
to the Public Subsidiary Stock
to the Public
Subsidiary
Stock Cash Stock

Public/Private
Subsidiary of
Equity Markets
Parent Firm
Tracking Stocks

Separate classes of common stock created by the parent for one or more
of its operating units (e.g., USX creates Marathon Oil stock in 1991)
Each class of stock links the shareholder’s return to the performance of
the individual operating unit
For the investor, such shares enable investment in a single operating
unit (i.e., a pure play) rather than in the parent
For the parent and the operating unit, such shares
– Give the parent another means of raising capital,
– Enable parent to retain control
– Represent an “acquisition currency” for the unit, and
– Provide an equity-based incentive plan to attract and maintain key
managers
May create conflict of interest
Tracking Stocks

Parent Firm
Parent Common Value of the
Tracking Stocks
Sub 1 Tracking Stock Tracking Stock
Issued by the
Parent Firm Sub 2 Tracking Stock Depends on the
Sub 3 Tracking Stock Performance of
Subsidiary

Subsidiary 1 Subsidiary 2 Subsidiary 3

Split-Offs

A variation of a spin-off in which parent company shareholders are

given the option to exchange their shares in the parent tax-free for
shares in a subsidiary of the parent firm. (e.g., AT&T spun-off its
wireless operations in 2001 to its shareholders for their AT&T
shares)
Frequently used when a parent owns a less than 100% investment
stake in a subsidiary in order to:
– Reduce pressure on the spun-off firm’s share price, because
shareholders who exchange their stock are less likely to sell the
new stock;
– Increase the parent’s EPS by reducing the number of its shares
outstanding; and
– Eliminates subsidiaries with minority shareholders
 Split-Offs

Stage 1: Exchange Offer Stage 2: Pro rata spin-off of any

remaining subsidiary shares
Parent
Former
Parent Stock Parent Firm Parent
Parent Firm
Firm Shareholders Firm
Shareholders
Subsidiary
Stock
• Subsidiary stock
Subsidiary
now held by former
Independent
Subsidiary parent shareholders.
of Former
• Parent has no
Parent
relationship with
former subsidiary
Voluntary Liquidations or Bust-Ups

Involves the sale of all of a firm’s individual

operating units
After paying off any remaining outstanding
liabilities, after-tax proceeds are returned to the
parent’s shareholders and the corporate shell is
dissolved
This option may be pursued if management views
the growth prospects of the consolidated firm as
limited
Choosing Appropriate Restructuring
Strategy: Viable Firms
Choice heavily influenced by the following:
– Parent’s need for cash
– Degree of operating unit’s synergy with parent
– Potential selling price of operating entity
Implications:
– Parent firms needing cash more likely to divest or engage in equity
carve-out for operations exhibiting high selling prices relative to
their synergy value
– Parent firms not needing cash more likely to spin-off units
exhibiting low selling prices and synergy with parent
– Parent firms with moderate cash needs likely to engage in equity
carve-out when unit’s selling price is low relative to synergy
Choosing Appropriate Restructuring
Strategy: Failing Firms
Choice heavily influenced by the following:
– Going concern (standalone) value of debtor firm
– Sale value of debtor firm
– Liquidation value of debtor firm
Implications:
– If sale value > going concern or liquidation value, sell
firm
– If going concern value > sale or liquidation value,
reach out of court settlement with creditors or seek
bankruptcy protection under the applicable laws
– If liquidation value > sale or going concern value,
reach out of court settlement with creditors and
liquidate under the applicable laws