Corporate restructuring and the LBO
CHAPTER 3: CONTRACTIONS
Contraction is the reduction in the size of the private company or business due to corporate restructuring.
3.1 Spin-Offs—A spin-off transaction is when a parent company separates the shares of its subsidiary from the original private company shares and distributes those shares, on a pro-rata basis to its shareholders. In essence, two separate entities are formed in which the stockholders are issued the shares in the legal subsidiary proportional to their original holdings in the parent company. Both the entities have their own management and run individually after the spin-off. The distribution of the subsidiary’s stock to shareholders is in the form of a dividend. This is typically a tax-free transaction for both the shareholders and the parent. Example:
Air-India has formed a separate company named Air-India Engineering Services Ltd., by spinning-off its engineering division. Guidant was spun out of Eli Lilly and Company in 1994, formed from Lilly's Medical Devices and Diagnostics Division. Agilent Technologies spun out of Hewlett-Packard in 1999, formed from HP's former test-and-measurement equipment division. Cenovus Energy was spun out of Encana Corporation in 2009
Shugart Associates was a spin-out of IBM.
3.2 Split-Offs—A split off is the separation of a subsidiary from the parent by splitting the shareholders of the parent company’s stock from the shareholders of the subsidiary’s stock. Most split-offs are tax-free transactions and used to downsize a company or defend against a hostile takeover. In a split-off a new company is created to take over the operations of an existing unit or division and some of the parent company’s shareholders will receive the stocks in subsidiary or in new private company in exchange for the parent private company’s stocks. As a result, the parent company will be able downsize its overall business
figure3.2.1: split offs
3.3 Split-Ups—A split up is when an entire firm is broken up in the series of spin-offs. After a split-up the company no longer exists, only the spun-off businesses of the original company survive. In a split-up transaction, new classes of stock are created to track the operations of each of the individual subsidiaries. The new classes of shares are distributed as a dividend to current stockholders and then the parent private company is dissolved. Example:The Andhra Pradesh State Electricity Board (APSEB) was split-up in 1999 as part of the Power Sector reforms. The power generation business and the transmission and distribution business has transferred to two separate companies called APGENCO and APTRANSCO respectively. APSEB ceased to exist as a result of split-up
3.4 Divestiture—A divestiture is a direct sale of a portion of the parent company to an outside party in return for cash. Generally a firm sells struggling operations that operate at a loss or require upkeep capital. A parent company may also divest non-strategic or non-gaining businesses and invest the proceeds of the sale in potentially higher return opportunities or core business expansion. Divestitures may also be used to realize the true potential of an outperforming asset, whose performance is not properly valued by the market. The tax basis of the asset intended for divestiture will be considered before deciding on the appropriate type of divestiture.
3.5 Carve-Out—An Equity carve-out is a sale of a portion of equity in a subsidiary to the public via an IPO. The parent private company retains the majority stake in the subsidiary, usually greater than 80%. With ownership of over 80%, the parent private company still retains the right to undertake spin-offs and split-offs on a tax free basis. In an equity carve-out, a new legal entity is created and issues new shares, which are distributed to outside investors figure3.5.1: carve outs....
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