Separation is never easy. It brings along a plethora of emotions ranging from grief and angst to relief and freedom. Akin to human lives, corporate entities also go through various phases of restructuring which sometimes calls for separation. But it is imperative that the separation happens for the right reasons, only then will the companies reap benefits.
In this article, we discuss the Spin Off and Split Off in detail.
- Reasons for Divestiture
- What is Spin off?
- Examples of Spin off:
- Number of Completed Spin-Offs by Year
- Types of Spin offs
- Split offs: A distant cousin of Spin off
- Split-off Examples
- Tax Treatment for Spin-offs
Reasons for Divestiture
Divestment or Divestiture is a phenomenon in the corporate landscape that entails partial or full disposal of the business unit with an intention of focusing on the more profitable or core models. As companies climb up the growth trajectory, managing diverse business lines become quite challenging and hence pruning the portfolio becomes an obvious choice. Some of the other reasons that justify divestiture are financial issues or to exploit the full potential of each entity as opposed to the consolidated entity.
Divestitures can take various forms like Spin-off, Split-off and Equity carve-out, however, it all depends on the reason for corporate restructuring. Usually, the business lines that are divested are the ones that have least synergies with the parent company.
What is Spin off?
In a spin-off, the shares of the subsidiary company or the company being spun-off is distributed as special dividends by the parent company, on a pro-rata basis. The parent company usually do not receive any cash consideration for undertaking the spin-off. Existing shareholders enjoy the benefit of holding shares of two companies instead of just one company. The hidden motive is to allow the Spin-off to have a distinct identity from parent company’s management. Sometimes the parent company spins off 100% of its shares in the subsidiary, while at times it may just spin off 80% to its shareholders and retain a minority interest of the holding. In fact, one of the pre-requisites of a Spin-off is that the parent company must renounce control of the subsidiary by distributing minimum 80% of its voting and non-voting shares.
Salient Features of Spin-off
- A parent company distributes the shares of a subsidiary in the form of a special dividend
- Stockholders hold shares in both the companies
- Two independent companies come into existence
- Effective removal of the parent company from management and decision-making of the subsidiary
source: Spin Off Research
Once the subsidiaries are freed from the control of the parent company, one can see fresh streaks of entrepreneurship at play. The independent new company usually operates with more accountability and responsibility.
Examples of Spin off:
Kraft Foods: Mondelez Spin Off
In October 2012, Kraft Foods Inc., spun off its North American grocery business, Kraft Foods Group in a corporate action which entailed distribution of the ratio of 1 share of Kraft Foods Group common stock for every 3 shares of the parent company’s common stock. Kraft Foods then renamed its snacks division as Mondelez International which houses brands such as Oreos, Cadbury, Wheat Thins, Ritz, and Trident. The grocery company was renamed Kraft Foods Group which focusses on grocery brands like Oscar Meyer, Nabisco, and Planters in North America.
Possible Reasons: The snacks and confectionery business had a wider exposure to high-growth emerging markets while the grocery business was more North America oriented and stagnating. Therefore to exploit best of both worlds and to manage two different segments in a focused way, this Spin-off was undertaken.
Baxter-Baxalta Spin Off
In 2014, leading healthcare company, Baxter International, Inc. (BAX) spun-off its bio-science arm, Baxalta Incorporated (BXLT). As per the terms of the deal, Baxter distributed 80.5% percent of the outstanding shares of Baxalta common stock and retained a 19.5% percent ownership stake in the company. For each share of Baxter common stock held, shareholders received one share of Baxalta common stock.
Possible Reasons: Both the businesses operate in distinct markets and had different risk profiles. Baxter was primarily specialized as a medical supplies company and the combination with Bioscience, a completely different portfolio, was making it difficult for operations and valuation. Therefore the management saw it in the best interest of the company to Spin-off the non-core arm.
Number of Completed Spin-Offs by Year
source: Spin Off Research
Types of Spin offs
Due to a variety of reasons of restructuring and plethora of reasons behind doing so, Spin-offs manifest itself in various forms. Some of the common ones are:
Pure Play is the most original form of Spin-off. This involves shareholders distributing shares of the subsidiary as a special dividend. Both the companies have a common shareholder base. This method is a stark contrast to an initial public offering (IPO), in which the parent company actually offloads some or all of its ownership in a division rather than just divesting it without any cash consideration. Pure Plays have gained momentum post-1990. The emerging competitive landscape motivates management to enhance operational efficiency and hone strategic decision-making skills.
Equity Carve out
Many people confuse Carve out with Pure Play. However, there are minor differences between the two. In Carve out the parent company sells an interest of less than 20% in the new subsidiary the public in a registered public offering (IPO) for cash proceeds instead of just existing shareholders. This is also known as a partial spin-off. When a corporation needs to raise capital, selling off a portion of a division while still holding control, proves to be a win-win situation for the company. There are other motivating factors also behind a carve-out as well. Sometimes a company might feel that a particular division has hidden potential and might perform well once it is spun-off. A separate stock garners more attention and enables investors to value the business independently.
As opposed to a spin-off where a division goes separate from the parent and establishes itself as a financially and managerial autonomous company, tracking stocks represent shares that are still very much a part of the parent (i.e no legal split of the assets or liabilities). The parent and tracking stock have a common management team and board of directors. However, the tracking stocks represent separate financial reporting and analysis from their parent company.
The Tracking stocks score some advantages (to the issuer) over spin offs. Issuing them is a tax-free procedure and if one of the two units undergo a financial loss, the earnings from one would make good the losses of the other for tax purposes. If the parent company enjoys a higher credit rating, the Tracking stocks can reap the advantage of lower borrowing costs. The more the synergies between the parent and tracker, the higher the advantages. Basically, these stocks are issued with the sole purpose of gaining from the high stock prices of the parent.
When a company distributes shares in a subsidiary to the public while retaining ownership to some extent, it is known as a Partial Spin-off. Once the spun-off unit or the subsidiary becomes publicly traded, we can determine the market value of the investment of parent company in the subsidiary.
If we subtract the intrinsic value of the subsidiary from the intrinsic value of the shares, we can arrive at the value of core operations of the parent, also known as the Stub
source: Spin Off Research
Split offs: A distant cousin of Spin off
We spoke enough about Spin-offs so now let us also shed some light on Split off, a distant cousin of Spin-off. Conceptually both are forms of divestiture, but there are differences between the corporate structures reorganizes themselves. Split-off means restructuring an existing corporate structure in which the stock of a business unit or a subsidiary is transferred to the shareholders of the parent company in lieu for stock in the latter. While on the other hand in Spin-off stocks in subsidiary are distributed to all existing shareholders just like the dividend.
In a split-off, the parent company gives a Tender offer to its shareholders to exchange their shares for new shares of a subsidiary. This tender offer usually gives a premium in order to encourage existing shareholders to go for the offer. This privilege of “premium” tells why split-offs usually end up being oversubscribed.
If the offer is oversubscribed, it means that more of the Parent shares are tendered than that of the subsidiary. When the shares are offered, the exchange happens on a pro-rata basis. On the flipside, if the tender offer is under-subscribed, it means that too few shareholders of parent company have accepted the tender offer. The Parent company will then usually distribute the remaining unsubscribed shares of the subsidiary on pro-rata through a spin-off.
source: Spin Off Research
Du Pont-Conoco Split Off
In October 1998, Du Pont generated $4.4 billion from an initial public offering of 30% of the shares of its Conoco unit. DuPont, through this proposed stock swap, planned to divest itself of its remaining stake of 70% in Conoco. In 1999, the former then designed plans for a final split from its Conoco Inc. oil unit, offering to swap Conoco’s stock worth $11.65 billion for about 13% of DuPont’s shares outstanding. At that time, this IPO was touted to be one of the largest in the history.
Possible Reasons: Conoco was a strong and steady contributor to DuPont’s revenue and cash flow but Dupont felt it was in best interests of both the companies to operate as separate entities and scale new heights. DuPont wanted to concentrate on its materials and life sciences business, while Conoco wanted to explore the imminent growth in energy markets.
Lockheed Martin-Martin Marietta Split Off
Lockheed Martin Corp. announced plans to split off the 81% interest it was holding in Martin Marietta Materials Inc., a highway construction material producing company. This Split-off was aimed to provide Martin Marietta Materials immense opportunity to pursue its growth strategy and finance the acquisitions it has planned. As per the terms of the Split off deal, 4.72 shares of Materials Common Stock for each share of Lockheed Martin Common Stock was distributed by the latter.
Possible Reasons: Lockheed was into substantial debt pile, estimated around $13 million and the move would generate enough cash to service the debt. Similarly, Martin Marietta Materials would be able to plan more inorganic growth through acquisitions and mergers.
Tax Treatment for Spin-offs
Spin offs have earned brownie points for being tax-free options. However, that not the case always. Whether a split-off will be tax-free or with taxable is decided in a manner which the parent company divests the subsidiary or a part of itself. The tax perspective is governed by Internal Revenue Code (IRC) Section 355. While financial viability is the key driving force behind Split-offs, it is also imperative that shareholders’ interest is taken care of. Usually, divestiture attracts long-term capital gains and hence the split-off has to be designed in such a way that they are tax-free.
One method to ensure that the distribution of shares in the new spin-off to existing shareholders indirectly proportional to their equity interest in the parent. Eg: If a stockholder has 3% holding in the parent company, his shareholding in the spin-off company will also be exact 3%.
In the second method, the parent company offers an option to the existing shareholders to exchange their shares in the parent company for an equal proportion of shares in the spinoff company or continue maintaining their holding in the company. Some also exercise the option of holding both the stocks. This is something on the lines of a Split-off.
A spin-off, split-off or equity carve-out are three varied methods of divestiture with the same objectives-Enhancing shareholder value, tax benefits, and improved profitability. While the goal of all these three methods is same, the selection amongst them is based on the broader corporate strategies of the parent company. Exit strategies are usually peppered with various challenges.
Carving out a company which is different from the core operations of the company requires thorough due diligence. A well-etched analysis of the strategy can build confidence in the process, get perfectly aligned operations and drive the entire transaction to realize its highest potential.
Separation complexities are onerous and involve negotiations at each step. A pre-conceived transition plan which clearly spells out the entire process and the work involved at each stage would go a long way in keeping things streamlined.
Next is focusing on the compliance perspective. The spun-off company should adhere to the prevalent financial reporting norms and be compliant with other internal and external controls as well as regulations like Sarbanes Oxley (SOX), SEC filings etc.
The company’s acumen to identify these challenges and underlying risk factors at the right time in the planning phase, while considering the key value drivers behind the divestiture, will lead to increased value generation from the chosen exit strategy.