Asset Stripping Definition
Asset Stripping is the process of selling assets of a company to generate dividends for the shareholders. It mostly happens when the company’s value as a whole is less than the combined value of assets. So investors generate profit by selling the assets individually and generating dividend for the shareholders.
Explanation
Asset Stripping is mostly done on undervalued companies. When an investor sees that a company is undervalued in the market, they try to value the Real Assets of the company in the market. Once the value of the assets is determined, and it is seen that the value of the individual assets is worth more than the company as a whole. Then they buy the undervalued company and sell off the assets individually in the market. The cash generated from the sale is distributed as a special dividend to the shareholders.
History
Carl Ichan, Victor Posner, and Nelson Peltz were investors in the year 1970s to 1980s. They started Asset Stripping as a practice to generate profit. Carl Icahn did a hostile takeover of “Trans World Airlines” in 1985 and sold its assets to pay for the debts of the takeover.
How does Asset Stripping Work?
- Step 1: Private Equity firms engaged in Asset Stripping practices look for undervalued companies with a strong asset base. Companies can be undervalued due to a lack of good management or other reasons.
- Step 2: The Private Equity firm looks for a market where he can sell the assets reasonably. Assets can be sold at a higher value when you get a strategic buyer, which means a person looking for a particular asset to do the production.
- Step 3: the value of the assets in the market is determined, then if the value of the assets is more than the value of the company as a whole, the process of acquiring of the company begins
- Step 4: Most of the acquisition is made by issuing debt. These are called Leveraged Buyout.
- Step 5: Once the company is bought, then the assets are sold to the strategic buyers and the money generated is used to repay the debt, and the rest is paid to shareholders as Special Dividend.
Example of Asset Stripping
Company A has five different businesses. Due to the current poor economic scenario caused by COVID-19, the company is trading below its Book Value. A private equity firm, who is engaged in Asset Stripping, starts to evaluate the businesses of the company. He found that the company’s worth now is $400M, but each business separately can be sold at $150M once the COVID-19 fear gets over. So the private equity firm acquired the undervalued company at $400M.
Solution
When the COVID-19 is over and the market recovers, the Private equity firm will sell individual businesses at $150M each.
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Total selling price = $150M * 5 (As there are five businesses and each can be sold @$150
= $750M
Profit = Selling Price – Buying Price
- = $750M – $400M
- = $ 350
Percentage of Profit = (Profit / Initial Investment) * 100
- = (350 / 400) * 100
- = 87.5%
So private equity firms make huge profits through Asset Stripping. The main challenge is to find the potential buyer for the assets. Private equity firms are engaged in this kind of business for the long term, so they have contacts worldwide, and it is easier for them to sell assets at a reasonable price.
Opportunities
Most Private Equity firms are engaged in Asset Stripping; they are continually looking for targets. Not all companies in the market are efficiently managed. Some companies are managed inefficiently. That is, the assets are not put to optimal usage. When a particular company is not managing assets properly, then they trade below their book value. In severe economic conditions like COVID-19, companies tend to be severely undervalued, which is the perfect opportunity for Asset Stripping. Undervalued companies will be bought and then sold part wise for greater profit when the economic condition improves.
Implications
When asset Stripping is done, mostly the assets which have economic value is being sold. So if a company loses its economic assets, it makes the company weaker as the company loses its assets, so it gets difficult for the company to raise more debts via collateral. The company gets weakened, so the debt charges increase as the company is prone to bankruptcy now.
Criticism
- Asset Stripping breaks a company in several parts, thus creating unemployment. Employees lose their jobs once the parts are sold to different buyers
- It is a loss for the economy as the company could have turned with proper management and with the change in the economy, but due to asset-stripping, it loses its value and slowly reaches bankruptcy
Advantages
- Shareholders who were suffering due to low share price gets their money back in the form of a special dividend
- Asset stripping is a threat to improperly managed companies. So managers tend to utilize the assets efficiently and manage companies optimally to save themselves from such situations.
Conclusion
Asset Stripping nowadays is mostly being performed by Private equity firms. It is a good way of generating profit for the investors, but it destroys the target. So in many countries, government regulations must be followed before applying such strategies.
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This article has been a guide to Asset Stripping and its definition. Here we discuss history, criticism, implications, and how does it work along with an example. You may learn more about financing from the following articles –
