Corporate Break-Ups

Prof. Ian Giddy

New York University

Mergers, Acquisitions & Divestitures

Mergers

& Acquisitions Divestitures Valuation

Concept: Is a division or firm worth more within the company, or outside it?
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Breaking Up

WhyThe business may be worth more outside the company than within HowSell to another company, or to the public, or give it to existing shareholders Tax AspectsAs a rule if you get paid in cash you realize a taxable gain; not otherwise Effect on ShareholdersThe bigger the part sold off, the greater the percentage gain

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Case Study: Pinault-Printemps-Redoute

Why? How? Tax Aspects? Effect on Shareholders?

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Corporate Financial Restructuring 4

Why Break Up?

Pro-active Defensive Involuntary Examples of each?

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Why Break Up?

Pro-active (GM tracking/selling DirectTV) Defensive (ABB selling ABB Cap Lease) Involuntary (ATT breakup, Enron) Examples of each?

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Why Break Up?

Post-acquisition disposals Shift of core business or strategy Underperforming business or mistake Lack of fit, refocus on core business Avoid competing with customers Antitrust compliance Need for funds Market or litigation risk

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Tax Consequences

The spin-off and related techniques have the advantage that they can be structured so as to be tax free (USA) Tax Code Section 355 requirements:

Both

the parent company and the spun-off entity must be in business for at least 5 years The subsidiary must be at least 80% owned by the parent
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Breaking Up

Breaking up Tax-Free Spin-Off Split-Up Tracking Stock Divestiture Taxable Equity Carve-Out Split-Off IPO Bust-Up

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Tax-Free Breakups
Spin-Off

Tax-Free Split-Up Tracking Stock

Spin-offspro-rata distribution by a company of all its shares in a subsidiary to all its own shareholders Split-offssome parent-company shareholders receive the subsidiary's shares in return for their shares in the parent Split-upsall of the parent company's subsidiaries are spun off and the parent company ceases to exist Tracking Stockspecial stock issued as dividend: pays a dividend based on the performance of a wholly-owned division
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Tracking Stock

Tracking stock, sometimes known as letter stock or alphabet stock, is a class of stock designed to reflect the value and track the performance of a part of the issuer's assets, usually a separate business or group of businesses. Claimed advantages:
preservation

of the efficiencies of a single

corporation ability of the market to more accurately value the respective businesses of the issuer

What does it really add?

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Taxable Breakups
Taxable Divestiture Equity Carve-Out Split-Off IPO Bust-Up

Divestituresthe sale of a division of the company to a third party Equity carve-outssome of a subsidiarys shares are offered for sale to the general public
Split-off

IPOsa private company offers a part of the company to the public

Bust-upsvoluntary liquidation of all of the companys business

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Copyright 2002 Ian H. Giddy

Divestitures Can Add Value

Shareholders of the selling firm seem to gain, depending on the fraction sold:
% of firm sold 0-10% 10-50% 50%+ Announcement effect 0 +2.5% +8%

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Corporate Financial Restructuring 13

Divestitures Can Add Value

Value of combined company Value of seller without sub + value of sub

(Seller may gain from more managerial focus, lower WACC, less conglomerate discount)

Value of sub standalone value Value of sub acquisition value to another company

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Break-up Computation
PPR with Finaref PPR without Finaref Finaref Standalone Finaref with CA EBITDA 800 500 300 330 Tax rate 40% 40% 40% 40% Beta 1.4 1 1.6 1.6 Growth rate 3.50% 2.50% 4% 4.50% Equity 8,000 6,000 3,000 3,500 Debt 7,000 5,000 0 0 Risk Free 3% 3% 3% 3% Mkt Risk Premium 7% 7% 7% 7% Debt spread 3% 2% 4% 2% Re 12.80% 10.00% 14.20% 14.20% Rd 6.00% 5.00% 7.00% 5.00% WACC 8.51% 6.82% 14.20% 14.20% Enterprise PV 16,538 11,868 3,059 3,555 Equity PV 9,538 6,868 3,059 3,555 Additional Gains/losses 1,187 0 - 1,400 Choice 9,538 11,114 10,155

Source: breakup.xls

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Framework for Assessing Restructuring Opportunities

Current market overpricing or underpricng

Current Market Value

Maximum restructuring opportunity

Companys DCF value 2

5 Restructuring Framework 4
Disposal/ Acquisition opportunities

Total restructured value

Financial structure improvements
(Eg Increase D/E)

Operating improvements

3
Potential value with internal improvements

Potential value with internal + external improvements

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Using The Restructuring Framework

($ Millions of Value)
$1,000 $ 25

Current perceptions Gap: Premium

$ 975

Current Market Price

$ 635

Maximum restructuring opportunity

Company value as is
Strategic and operating opportunities

2
Restructuring Framework

Optimal restructured value

Financial engineering opportunities

$ 1,635

$ 300

$ 10

3
Potential value with internal improvements
$ 1,275 Disposal/ Acquisition opportunities

Eg Increase D/E

Potential value with internal and external improvements

$ 1,625

$ 350
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Marriott
The Choice the decision of whether to split Marriott Corp. into two companies--Marriott International and Host Marriott The Situation decline in real estate values has a significant percentage of assets in hotels it had planned to sell difficult for Marriott to pursue growth strategies market price of the company had declined significantly
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Marriott: Assignment

Will this type of reorganization meaningfully improve the company? What are the different way of effecting break-ups? In the Marriott case, are there reasonable alternative approaches? Draw up a spreadsheet comparing the before-and-after capital structure of Marriott and its proposed component parts How are bondholders affected? How can they protect their interests? Make a recommendation, and justify it.
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Marriott: Project Chariot

Marriott Corp.

Marriott Intl.

Host Marriott Corp.

Intangibles Franchises

Hotels Airport and Road Plazas Land

Management Services
Distribution Services Timeshares

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Marriott: Breaking Up

Breaking up Tax-Free Spin-Off Split-Up Tracking Stock Divestiture Taxable Equity Carve-Out Split-Off IPO Bust-Up

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Marriott: Financial Restructuring

Marriott Corp. Marriott Intl Host Marriott Long-term debt 2732 378 2362 LYONs 228 205.2 22.8 Convertible preferred 200 200 Shareholders' equity 585 524 61 Total long-term capital 3745 1107.2 2645.8 Long-term debt/Total 73% 34% 89%

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Corporate Restructuring
Divestiturea reverse acquisitionis evidence that "bigger is not necessarily better" Going privatethe reverse of an IPO (initial public offering)contradicts the view that publicly held corporations are the most efficient vehicles to organize investment.

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Contact Info
Ian H. Giddy NYU Stern School of Business Tel 212-998-0426; Fax 212-995-4233 Ian.giddy@nyu.edu http://giddy.org

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