Spin-off transactions require a focused, intensive planning effort. The deal team must make decisions about how best to allocate businesses, assets and liabilities between the parent and the subsidiary that will be spun-off. It must address complex tax issues, securities law questions and accounting matters, as well as issues related to capital structure, financing and personnel matters. In addition, it must resolve a long list of governance issues, including questions about the composition of the spin-off company board, the importance of mechanisms for dealing with conflicts of interest and the desirability of robust takeover defenses.
Posts Tagged ‘Spinoffs’
Spin-offs continue to be a prominent feature of the deal landscape; new transactions are announced on an almost weekly basis. For example, Barnes & Noble recently said that it plans to spin off its Nook business, eBay said that it would spin off PayPal, and Hewlett Packard announced that it would spin off its printer and computer business. A total of approximately 51 separation transactions have been announced so far this year. The tally was not quite as high in 2013, but still robust; approximately 42 transactions were announced.
When market analysts seek to explain this apparently never-ending stream of separation transactions, they reason that the stock market rewards pure-play companies focused on a single line of business with higher stock prices than conglomerates. They also observe that activists have added momentum to the transaction flow by encouraging companies that operate several lines of business to consider separation opportunities. In addition, they observe that separation transactions can result in improved management focus, enable the implementation of more efficient capital structures and compensation programs, and result in the creation of a new equity currency.
A spin-off involves the separation of a company’s businesses through the creation of one or more separate, publicly traded companies. Spin-offs have been popular because many investors, boards and managers believe that certain businesses may command higher valuations if owned and managed separately, rather than as part of the same enterprise. An added benefit is that a spin-off can often be accomplished in a manner that is tax-free to both the existing public company (referred to as the parent) and its shareholders. Moreover, recently, robust debt markets have enabled companies to lock in low borrowing costs for the business being separated and monetize a portion of its value. For example, in connection with its $55 billion spin-off from Abbott Laboratories in 2012, AbbVie conducted a $14.7 billion bond offering, which at the time was the largest ever investment-grade corporate bond deal in the United States, at a weighted average interest rate of approximately two percent. Other notable recent spin-offs include ConocoPhillips’ spin-off of its refining and marketing business, Penn National Gaming’s spin-off of its real estate assets into the first-ever casino REIT, Sears Holding Corporation’s planned spin-off of Lands’ End, FMC’s planned spin-off of its minerals division, Rayonier’s planned spin-off of its performance fibers division, Simon Property’s spin-off of its strip center business and smaller enclosed malls into a REIT, and Darden’s planned spin-off of Red Lobster. There were 201 spin-offs announced in 2013 and 176 in 2012, with an aggregate value of $33 billion and $41 billion, respectively.
China Natural Resources, Inc. (“CHNR”), a natural resources company based in the People’s Republic of China (the “PRC”) with shares listed on the NASDAQ Capital Market, recently completed the spin-off (the “Spin-Off”) and listing by introduction (the “Listing by Introduction”) on The Stock Exchange of Hong Kong Limited (the “Hong Kong Stock Exchange”) of its wholly-owned subsidiary, Feishang Anthracite Resources Limited (“Feishang Anthracite”), which operated CHNR’s coal mining and related businesses prior to the Spin-Off.  S&C represented CHNR and Feishang Anthracite in connection with the Spin-Off and Listing by Introduction, which is the first-of-its-kind where a U.S.-listed company successfully spun off and listed shares of its businesses on the Hong Kong Stock Exchange, including advising on the U.S. and Hong Kong legal issues that arose in connection with this transaction.
Corporate governance incentives at too-big-to-fail financial firms deserve systematic examination. For industrial conglomerates that have grown too large, internal and external corporate structural pressures push to re-size the firm. External activists press it to restructure to raise its stock market value. Inside the firm, boards and managers see that the too-big firm can be more efficient and more profitable if restructured via spin-offs and sales. But for large, too-big-to-fail financial firms (1) if the value captured by being too-big-to-fail lowers the firms’ financing costs enough and (2) if a resized firm or the spun-off entities would lose that funding benefit, then a major constraint on industrial firm over-expansion breaks down for too-big-to-fail finance.
Propositions (1) and (2) have both been true and, consequently, a major retardant to industrial firm over-expansion has been missing in the large financial firm. Debt cost savings from the implicit subsidy can amount to a good fraction of the big firms’ profits. Directors contemplating spin-offs at a too-big-to-fail financial firm accordingly face the problem that the spun-off, smaller firms would lose access to cheaper too-big-to-fail funding. Hence, they will be relatively more reluctant to push for break-up, for spin-offs, or for slowing expansion. They would get a better managed group of financial firms if their restructuring succeeded, but would lose the too-big-to-fail subsidy embedded in any lowered funding costs. Subtly but pervasively, internal corporate counterpressures that resist excessive bulk, size, and growth degrade.
Although the structure of the board of directors has been the topic of considerable debate and academic research over the past two decades, much of this prior literature focuses on aggregate measures of board composition such as board size or the fraction of independent outside directors. More recent studies recognize that directors with differing backgrounds and expertise are likely to bring different sources of value to the board. However, empirical studies of the importance of these attributes are limited by the ‘stickiness’ of board structures. Specifically, transactions costs associated with board structure adjustments can result in board structures that evolve only very slowly. As a result, observing board structures and their determinants at any given point in time can provide a misleading picture of how boards are formed; most notably, how and why particular individual directors are matched with the specific set of assets that they help govern.
In our paper, Matching Directors with Firms: Evidence from Board Structure Following Corporate Spinoffs, which was recently made publicly available on SSRN, we aim to overcome some of these limitations by analyzing board structure following corporate spinoffs. As part of the spinoff, a board of directors must be created from scratch for the spun off unit. This ‘de novo’ feature provides a unique opportunity to observe boards that are unlikely to be affected by the factors that contribute to the ‘stickiness’ of ongoing boards. In addition, the separation of one publicly traded firm into two publicly-traded firms leads to large discrete differences in asset and operating structure and significant variation in CEO identity and origin. This allows us to examine both the formation of new boards by the spun off units and the changes in parent board structure occasioned by a significant operational restructuring. Perhaps more importantly, our experimental design allows us to link specific assets with specific directors, thereby providing unique evidence on how directors are matched with the assets they govern. Similarly, by tracking the movement of individual CEOs and individual directors, our data can enhance our understanding of the extent to which individual directors are matched with specific CEOs.
Even with the recent slowdown in M&A activity, spin-offs have been among the transactions of choice in the past year. With everyone from economic mainstays like ConocoPhillips and Kraft to high-profile new players like TripAdvisor engaging in separation deals in the latest round of deconsolidation, it is an opportune time for dealmakers to consider the general implications of a spin-off on transformational corporate merger activity and certain structures that may allow for a combination of the two.
Corporations engage in spin-offs for a variety of business and financial reasons. A corporation’s goals can be accomplished without U.S. federal income tax to the distributing corporation and its stockholders so long as the transaction meets the requirements of Section 355 of the Internal Revenue Code.
Failure to meet these requirements either before or after the transaction can cause a spin-off to be taxable to the distributing parent company (in the form of corporate- level gain generally equal to the appreciated value of the spun-off subsidiary), to the distributing parent’s stockholders (in the form of dividend income equal to the value of the spun-off business), or both. These taxes can be prohibitively or even catastrophically expensive.
The Delaware Chancery Court has issued its decision in the closely watched trial between Barry Diller and John Malone and their respective companies, IAC and Liberty Media.
Liberty owns all the high-voting stock and a majority of the votes in IAC but it has granted Diller, IAC’s CEO, an irrevocable proxy to vote these shares. IAC has proposed to spin-off four of its subsidiaries as independent public companies, and the dispute between IAC’s management (including Diller) and Liberty (including its Chairman, John Malone) is whether or not to replicate the IAC two-tiered voting structure in these spin-offs. Diller is contemplating voting Liberty’s shares in favor of the proposal which Liberty vehemently opposes.
The clear winner in this round seems to be Diller. The court concluded that Liberty failed to demonstrate that Diller breached or threatened to breach any contractual duty he owes to Liberty, and rejected Liberty’s claim that the proposed single-tier spin-off gives rise to any right of consent on Liberty’s part. The court held that it was premature to rule on claims relating to the fiduciary duties of the IAC board of directors. IAC was represented by our frequent blog contributor Theodore Mirvis and his partners at Wachtell Lipton Rosen & Katz.
The full opinion can be found here.