Divestitures

Submitted by:
Megha Bakshi
Lalit Sondhi
MBA-IB

Submitted to:
Prof. Meena Sharma
 Table of Contents:
Divestiture-Meaning
Rationale for divestiture
Spin-offs
Strategic rationale for spin-offs
Tax implications
Accounting for Spin-offs
Monetization techniques
Split-up
Split-offs
Equity Carve-outs
Examples
Questions
 •A divestiture is the partial or full disposal of a

Divestiture business unit through sale, exchange, closure or

bankruptcy.
•A divestiture most commonly results from a
management decision to cease operating a business unit
because it is not part of a core competency.
•It may also occur if a business unit is deemed to be
redundant after a merger or acquisition, if the disposal
of a unit increases the resale value of the firm, or if a
court requires the sale of a business unit to improve
market competition.
•While the choice of a specific method by the parent
company depends on a number of factors but the
ultimate objective is to increase shareholder value.
 •Focusing on best competences
Rationale for •Correct negative synergies
•Underperforming business units
divestitures •Good business opportunity
•Strategic freedom
•Resolving conflicts
•Avoiding organisational costs
•Improving market transparencies
and unlocking hidden value
•Poison pill
•Comply with legal requirements
 •In a spin-off, the parent company

Spin-Offs
distributes to its existing shareholders,
new shares in a subsidiary, thereby
creating a separate legal entity with its
own management team and board of
directors.
• The distribution is conducted pro-
rata, such that each existing
shareholder receives stock of the
subsidiary in proportion to the amount
of parent company stock already held.
•No cash changes hands, and the
shareholders of the original parent
company become the shareholders of
the newly spun company (Spin Co).
Strategic Rationale
•Unlocking hidden value – Establish a public market
valuation for undervalued assets and create a pure-play
entity that is transparent and easier to value
•Undiversification – Divest non-core businesses and
sharpen strategic focus when direct sale to a strategic or
financial buyer is either not compelling or not possible
•Institutional sponsorship – Promote equity research
coverage and ownership by sophisticated institutional
investors, either of which tend to validate SpinCo as a
standalone business
•Public currency – Create a public currency for
acquisitions and stock-based compensation programs
•Motivating management – Improve performance by
better aligning management incentives with SpinCo's
performance (using SpinCo, rather than ParentCo,
stock-based awards), creating direct accountability to
public shareholders, and increasing transparency into
management performance.
Strategic Rationale
● Eliminating dissynergies – Reduce
bureaucracy and give SpinCo
management complete autonomy
● Anti-trust – Break up a business in
response to anti-trust concerns
● Corporate defense – Divest "crown
jewel" assets to make a hostile
takeover of ParentCo less attractive
Tax Implications
A spin-off is usually tax-free under Internal Revenue
Code (IRC) Section 355, meaning that no taxable gain
is recognized by either the parent entity or the parent's
existing shareholders. To qualify for favourable tax
treatment, the spin-off must meet the requirements of
Section 355:
•The parent and subsidiary must both have been
engaged in an "active trade or business" the entire 5
years preceding the spin-off, and neither entity may
have been acquired during that period in a taxable
transaction.
•ParentCo and SpinCo must continue in an active trade
or business following separation.
•ParentCo must have tax control before the spin-off,
defined as ownership of at least 80% of the vote and
value of all classes of subsidiary stock.
Tax Implications
•ParentCo must relinquish tax control as a result of the
spin-off (< 80% vote and value).
•The spin-off must have a valid business purpose, and
cannot be used as a "device" to distribute earnings
(dividends).
•The parent's shareholders, collectively, must retain
continuity of interest in both parent and subsidiary for a
4-year period beginning 2 years before the spin-off by
maintaining 50% equity ownership interest in both
companies (a change in control of either ParentCo or
SpinCo during this period could trigger a tax liability
for the ParentCo). This is the anti-Morris Trust rule.
Accounting for
•From the announcement of the spin-off until the date it
is completed, the parent accounts for the disposition of
its subsidiary in a single line item on its balance sheet
called Net Assets of Discontinued Operations, or

Spin-Offs
similar. The parent also segregates the net income
attributable to the subsidiary on its income statement in
an account called Income from Discontinued
Operations, or similar.

Parent's Journal Entry

The spin-off is recorded at book
dr. Retained earnings
value on the transaction date as
cr. Net assets of discontinued
operations shown:
Subsidiary's Journal Entry
dr. Assets
cr. Liabilities
cr. Equity
Monetization
•The parent company will often extract value from the
subsidiary before spinning it off by levering up SpinCo
and siphoning the cash proceeds as a special tax-free
dividend (courtesy of the 100% DRD) or pushing down

Techniques
debt to SpinCo.
•The special dividend and amount of debt pushdown
are both limited in size to ParentCo's inside basis in the
subsidiary's assets.
•If either exceeds the inside basis, the spin-off is
taxable to the extent of the excess.
•The amount of debt ParentCo can push down to
SpinCo is also limited by SpinCo's ability to service the
debt.
 •A split-up is a corporate action in which a single
company splits into two or more separately run

Split-up
companies.
• Shares of the original company are exchanged for
shares in the new companies, with the exact
distribution of shares depending on each situation.
•This is an effective way to break up a company into
several independent companies.
•A company can split up for many reasons, but it
typically happens for strategic reasons or because the
government mandates it.
•The government can also force the splitting up of a
company, usually due to concerns over monopolistic
practices.
•It would be much more advantageous to stockholders
to split up the company into different independent
companies, so that each segment can be managed
separately to maximize profitability.
 •In a split-off, shareholders in the parent company are

Split-offs
offered shares in a subsidiary, but the catch is that
they have to choose between holding shares of the
subsidiary or the parent company.
•A shareholder thus has two choices:
(a) continue holding shares in the parent company,
or
(b) exchange some or all of the shares held in the
parent company for shares in the subsidiary.
•Because shareholders in the parent company can
choose whether or not to participate in the split-off,
distribution of the subsidiary shares is not pro rata as
it is in the case of a spin-off.
•A split-off is generally accomplished after shares of
the subsidiary have earlier been sold in an IPO through
a carve-out.

The benefit of a split-off to the
parent company is that it is
akin to a stock buyback, except
that stock in the subsidiary is
being used rather than cash
for the buyback; this offsets
part of the share dilution that
typically arises in a spin-off.
•Since the subsidiary now has a certain market value,
it can be used to determine the split-off's exchange
ratio.
The exchange ratio is the relative number of new
shares that will be given to existing shareholders of a
company that has been acquired or has merged with
another.
•In order to induce parent company shareholders to
exchange their shares, an investor will usually receive
shares in the subsidiary that are worth a little more
than the parent company shares being exchanged.
For example, for $1.00 of a parent company share,
the shareholder may receive $1.10 of a subsidiary
share.
Equity Carve-outs
•In a carve-out, the parent company sells some or all
of the shares in its subsidiary to the public through an
initial public offering (IPO).
• A company undertaking a carve-out is not selling a
business unit outright but, instead, is selling an equity
stake in that business or spinning the business off on
its own while retaining an equity stake itself.
•Unlike a spin-off, the parent company generally
receives a cash inflow through a carve-out.
•Since shares are sold to the public, a carve-out also
establishes a net set of shareholders in the subsidiary.
• A carve-out often precedes the full spin-off of the
subsidiary to the parent company's shareholders.
Equity Carve-outs
•In order for such a future spin-off to be tax-free, it has
to satisfy the 80% control requirement, which means
that not more than 20% of the subsidiary's stock can
be offered in an IPO.
• Sometimes a business unit is deeply integrated,
making it hard for the company to sell the unit off
completely while keeping it solvent.
•Those looking at investing in the carve-out must
consider what might happen if the original company
completely cuts ties and what prompted the carve-out
in the first place.
Two Types of Carve- •Equity Carve-outs
❖ In an equity carve-out, a business

Outs sells shares in a business unit.

❖ The equity carve-out allows the
company to receive cash for the
shares it sells now.
❖ This type of carve-out may be used if
the company does not believe that a
single buyer for the entire business is
available or if the company wants to
maintain some control over the
business unit.
Two Types of Carve- •Spin-off Carve-outs
❖ In this strategy, the company divests

Outs a business unit by making that unit

its own standalone company.
❖ Rather than selling shares in the
business unit publicly, current
investors are given shares in the new
company.
❖ The business unit spun off is now an
independent company with its own
shareholders, though the original
parent company may still own an
equity stake.
In a study of the performance
of the 200 largest U.S.
corporations from 1990 to
2000, McKinsey & Company
found that those companies
that actively manage their
business portfolios through
acquisitions and divestitures
create substantially more
shareholder value than those
that passively hold their
businesses.
EBAY spun-off
•Parent company- EBAY
•Subsidiary company- PAYPAL

PAYPAL
•Spin-off held on July 17,2015
•Each eBay shareholder received one share
of PayPal common stock per eBay share.
•PayPal's shares rose 5.4% to close at
$40.47. eBay's shares gained 2.4% to
close at $28.57, giving the marketplace a
$35 billion valuation.
•PayPal's market value climbed to near $49
billion, eclipsing the market cap of its
former parent company eBay.
 •Parent company- FIAT CHRYSLER

Ferrari spins from

AUTOMOBILES
•Spin company- FERRARI

Fiat
•As part of the spin-off, FCA's
shareholders received one Ferrari share for
every 10 Fiat Chrysler shares they owned.
•In addition, special voting shares are
being distributed in the same proportions
to certain shareholders as well.
•Ferrari had accounted for more than 10
percent of FCA’s total profit. With the
brand now out of the group, FCA’s shares
opened almost a third lower than the most
recent closing price on Monday. Ferrari’s
share price was also slightly lower.
Questions •What is a Split-off?
•What is a Carve-out?
•Your opinions on why
to divest?
•http://www.mckinsey.com/business-
functions/strategy-and-corporate-
finance/our-insights/divestitures-how-to-
invest-for-success
•http://www.investopedia.com/articles/in
vesting/090715/comparing-spinoffs-
splitoffs-and-carveouts.asp
•https://www.firmex.com/thedealroom/is
-2015-a-game-changing-year-for-
divestitures/
Thank
You