📈Corporate Strategy and Valuation Unit 19 – Corporate Restructuring & Spin-Offs

Key Concepts and Definitions

• Corporate restructuring involves significant changes to a company's business model, capital structure, or operations to improve performance, competitiveness, or shareholder value
• Spin-offs are a type of corporate restructuring where a company divests a subsidiary or business unit into a separate, independent company
• Divestiture refers to the sale, exchange, closure, or bankruptcy of a business unit or subsidiary
• Carve-outs are a partial divestiture where a company sells a minority stake in a subsidiary through an initial public offering (IPO)
• Tracking stocks are a type of common stock issued by a parent company to track the performance of a particular division or business unit without giving shareholders direct ownership or voting rights
• Conglomerates are companies that operate in multiple, often unrelated, business segments or industries
• Conglomerate discount refers to the market valuation of a diversified company being lower than the sum of its individual business units

Motivations for Corporate Restructuring

• Enhancing focus on core competencies by divesting non-core or underperforming business units (GE, IBM)
• Unlocking hidden value in a subsidiary or division that may be obscured within the larger company
• Improving financial performance by reducing debt, increasing cash flow, or optimizing capital structure
• Responding to changes in market conditions, consumer preferences, or competitive landscape
• Resolving conflicts between business units or management teams
• Enhancing transparency and analyst coverage for the spun-off entity
• Achieving tax benefits or regulatory compliance by separating certain business activities
• Raising capital for growth or investment in the parent company or spun-off entity

Types of Corporate Restructuring

• Spin-offs involve distributing shares of a subsidiary to the parent company's shareholders, creating a separate publicly traded company (PayPal from eBay)
• Split-offs are similar to spin-offs but allow shareholders to exchange their parent company shares for shares in the newly created entity
• Carve-outs involve selling a minority stake in a subsidiary through an IPO while the parent company retains a controlling interest (Synchrony Financial from GE)
• Tracking stocks are issued to track the performance of a specific business unit but do not grant direct ownership or control (Liberty Media's tracking stocks for Formula One and SiriusXM)
• Divestitures involve selling, exchanging, or closing a business unit or subsidiary (Procter & Gamble divesting Duracell to Berkshire Hathaway)
  • Asset sales are a type of divestiture where specific assets are sold rather than an entire business unit
  • Equity carve-outs are a type of divestiture where a portion of a subsidiary's equity is sold to outside investors
• Liquidations involve selling all of a company's assets and distributing the proceeds to shareholders before dissolving the company

Spin-Off Process and Mechanics

• Identification of the business unit or subsidiary to be spun off based on strategic, financial, and operational considerations
• Determination of the spin-off structure, including the distribution ratio and any special dividends or share repurchases
• Preparation of the subsidiary for independence, including establishing separate management teams, financial systems, and corporate governance
• Filing of a Form 10 registration statement with the SEC detailing the spin-off plan and financial information of the new entity
• Obtaining tax rulings from the IRS to ensure the spin-off qualifies as a tax-free distribution under Section 355 of the Internal Revenue Code
• Securing approval from the board of directors and shareholders, if required
• Distribution of the subsidiary's shares to the parent company's shareholders on a pro-rata basis
• Establishment of the spun-off entity as a separate publicly traded company with its own stock listing and ticker symbol

Valuation Techniques in Restructuring

• Sum-of-the-Parts (SOTP) analysis values each business unit or subsidiary separately and aggregates them to determine the company's total value
  • Identifies potential value creation opportunities through restructuring by highlighting the value of individual business units
  • Helps determine the appropriate distribution ratio for spin-offs based on the relative values of the parent and subsidiary
• Discounted Cash Flow (DCF) analysis projects the future cash flows of the parent company and the spun-off entity separately to determine their intrinsic values
• Comparable Company analysis compares the valuation multiples of the parent company and spun-off entity to similar publicly traded companies in their respective industries
• Precedent Transaction analysis examines the valuation multiples paid in previous spin-offs or divestitures within the same industry
• Leveraged Buyout (LBO) analysis assesses the potential returns for private equity firms or other investors considering acquiring the spun-off entity

Financial and Strategic Implications

• Improved transparency and clarity for investors by separating disparate business units with different growth prospects, capital requirements, or risk profiles
• Increased focus and efficiency for both the parent company and spun-off entity by allowing management to concentrate on their respective core competencies
• Potential reduction in the conglomerate discount as the market assigns higher valuations to more focused, standalone companies
• Enhanced access to capital markets for the spun-off entity, which can issue its own equity or debt securities to fund growth or acquisitions
• Possible changes in dividend policy or capital allocation as the parent company and spun-off entity adjust their financial strategies
• Realignment of management incentives through new compensation plans or equity ownership in the spun-off entity
• Potential loss of synergies or economies of scale that existed within the combined company
• Short-term volatility in stock prices as investors rebalance their portfolios and assess the value of the separate companies

Legal and Regulatory Considerations

• Compliance with SEC regulations, including filing a Form 10 registration statement and providing audited financial statements for the spun-off entity
• Obtaining a favorable tax ruling from the IRS to ensure the spin-off qualifies as a tax-free distribution under Section 355 of the Internal Revenue Code
  • Requirements include the parent company distributing at least 80% of the subsidiary's shares, maintaining a valid business purpose, and not using the spin-off as a device for distributing earnings and profits
• Navigating antitrust laws and obtaining regulatory approvals, particularly if the spin-off involves a highly concentrated industry or has significant market share
• Addressing intellectual property rights, licenses, and shared contracts between the parent company and spun-off entity
• Complying with state and international laws, especially if the spin-off involves foreign subsidiaries or cross-border transactions
• Managing potential litigation or shareholder disputes related to the spin-off process or valuation

Case Studies and Real-World Examples

• eBay's spin-off of PayPal in 2015 to unlock value and enable each company to focus on its core business (e-commerce and digital payments, respectively)
• Hewlett-Packard's split into HP Inc. (personal computers and printers) and Hewlett Packard Enterprise (servers, storage, and networking) in 2015 to adapt to changing market conditions
• Danaher Corporation's spin-off of Fortive Corporation in 2016 to separate its industrial technologies and professional instrumentation businesses
• General Electric's ongoing restructuring efforts, including the spin-off of GE Healthcare and the sale of GE Biopharma to Danaher in 2019
• DowDuPont's separation into three independent companies (Dow, DuPont, and Corteva) in 2019 following the merger of Dow Chemical and DuPont
• Pfizer's spin-off of its off-patent and generic drug business, Upjohn, and subsequent merger with Mylan to form Viatris in 2020
• Johnson & Johnson's planned split into two companies, separating its consumer health business from its pharmaceutical and medical device segments, announced in 2021