For the past few articles, we have mentioned the word “Spinoffs” several times. We discussed what it is in passing. Today, we will dive deeper into what spinoffs are, and the role they play in corporate restructuring.
What Are Spinoffs?
Spinoffs are a large part of the corporate restructuring strategy. In spinoffs, the parent company often handouts shares in the parent company in the business it is getting rid of. The said shares are given to investors according to their interest in the founding organization.
For the most part, spinoffs are an alternative to outright divestiture. As you may recall, in divestitures, the company sells the unit and receives cash or other consideration.
MetLife, Inc.’s 2017 spinoff of Brighthouse Financial is a great example. Brighthouse Financial is MetLife, Inc.’s United States life insurance and annuity business.
They were motivated to do the spinoff because of their desire to separate the slow-growth U.S. life and annuity business from the rest of the company. Additionally, that had hoped that an independent spinoff such as Brighthouse might be more nimble on its own. There’s even a chance of it growing faster.
What Happens After Spinoffs?
After the parent company decides to separate a division and turn it into a spinoff, the spun-off entity becomes a completely separate business. Which means that these entities are completely independent of the parent company.
Yes, both the parent and the spinoff are two separate companies that operate independently. However, they do share the same shareholders.
How does this happen, you ask? Well, there is a pro-rata distribution to the parent company’s shareholders. This is usually done through what they call a dividend.
Now, because they do the spinoff through the payment of a dividend, courts usually regard dividend payments as part of the normal responsibilities of the board of directors. At the end of the day, shareholder approval is usually unnecessary unless the amount of assets they are trying to spinoff is substantial.
In a spinoff, the shareholders involved in the transaction may stay the same as the original company. On the other hand, an equity carve-out may need to establish a new set of shareholders. We will discuss more equity carve-outs in a later article.
Keep in mind that there are other variations that the parent company can try. This includes a sponsored spinoff.
What Are Sponsored Spinoffs?
Sponsored spinoffs happen when an outside party acquires an interest in the spun-off entity. They often do this by giving the sponsor an incentive. Usually, incentives like these come in the form of a discount on the price of the shares.
Additionally, the spun-off entity and the remaining parent company divides the debt of the overall company. They typically do this in relation to the respective post-transaction sizes of the respective business.
For instance, if the company has warrants and outstanding convertible debt, they may need to adjust the conversion ratio. This is while the stock price of a company may adjust downward. Usually, this happens in the case of more significant spinoffs.
Additionally, shareholders may directly gain by maintaining their original shares from the parent company. They will also receive their shares in the spun-off entity.
If they don’t consider it carefully, warrant and convertible debt holders may not realize gains. Hence, it is vital to take these factors into account when structuring a deal.
Usually, spinoffs are easier to implement. These are also a less expensive option as opposed to equity carve-outs. For instance, there was a study that concluded that it is four times as expensive to implement a carve-out compared to spinoffs.
On another note, spinoffs are less time-consuming to implement than equity carve-outs. If the spun off business is well integrated into the parent company, then there will usually be more work to do. However, if the business was a prior acquisition that was not well integrated into the parent company, the job is so much easier.
Trends in Spinoffs
The dollar volume of spinoffs varies. However, it does somewhat follow the M&A volume. For instance, spinoff volume in the United States fell after the subprime crisis, just like in mergers and acquisitions. It spiked back up in 2011 only to fall again. It also happened worldwide; in Europe, in Asia, and more.
Tax Treatment of Spinoffs
Another great advantage of a spinoff is that it may qualify for tax-free treatment. Compared to outright divestitures, spunoff entities may be eligible to be tax-free.
Naturally, there are certain requirements by the IRS or the Internal Revenue Code that must be met. Discussing these rules will be far too time-consuming and complex. Tax attorneys are crucial at a point like this. Companies have tax attorneys on retainers specifically for these cases.
Tax attorneys are important for M&As. However, in spinoffs, they are most especially needed.
For instance, the parent company must own at least 80% of the shares of the spin off entity to qualify for tax-free treatment. In addition to that, the parent company must not have acquired control of the unit less than five years ago.
These are only examples of the requirements you will need. These types of transactions must also satisfy the business purpose test.
Shareholder Wealth Effects of Spinoffs
It comes as no surprise that the market likes spinoffs. These transactions accomplish many of the same objectives as divestitures. However, it must be done without the possible adverse tax effects.
There are instances when activists believe that a unit could be readily sold at an attractive premium. If the company includes some unattractive parts, it would be more difficult to sell the overall company.
Once the spinoff is done, the newly spun-off entity may be more of a pure play. It is now allowed to be a more focused business. This is the reason it might be simpler to discover vital purchasers for the business.
If the parent company does this right, they may be able to realize a premium on the marketable part of the business. This leads to releasing value to investors.
© Image credits to Damon Hall