So up to this stage our analysis has considered how firms might create value by acquiring other business units. Now, let's flip the analysis and consider how value might be unlocked by separating out different business units by divestitures, spinoffs, and equity carve-outs. We define corporate restructuring as a transaction that involves the company, either disposing of assets entirely as in the case of divestitures. Or alternatively separating our business units into distinct entities, as is the case with spin-offs and equity carve-outs. The reasons generally put forward for such transactions, range from a better alignment of managerial and shareholder objectives to forcing management teams to become more focused on core activities. To signaling to the market a more accurate description of the true value of the separate entities. One thing that is commonly understood with corporate restructuring is that it is designed primarily to unlock what is know as the Diversification Discount. So what is the Diversification Discount? To describe it, let's have a look at a seminal piece of research in the area by Philip Berger and Eli Ofek, published way back in 1995. In that paper, they examined the effects of diversification by estimating the value of the separate business units operating within a multi segment firm using accounting multiples. And then comparing these imputed values against the value of single segment firms operating in the same industry. Now, what they found was astonishing. They found that multi-segment firms experienced a value loss that ranged from 12.7% to 15.2% depending upon which multiple was used for valuation. This is the essence of the diversification discount. They then explored reasons for the discount and found that it could be linked to two main factors. Firstly, diversified firms tended to over-invest. That is they invested even when projects had negative net present values. Secondly, they found strong evidence of cross-subsidization. That is poorly performing units were kept afloat by business units that were performing well. They then went on to find that these effects were reduced when the different business units operated in related industries. So was there any upside associated with diversification of a firm's operations? Well, yes. Firstly, a diversified firm had better debt capacity as the combination of different business units reduced the volatility of the earning stream. Secondly, there was a more efficient usage of tax shields as the tax losses incurred by the poorly performing units could be quickly offset against the income generated by the profitable units. The key point is though, that even after accounting for these benefits the diversification discount was still present. So let's move to our first form of corporate restructuring, divestitures. This is simply where a firm sells off a business unit and receives cash as a result. Common reasons for divestitures include the fact that the management team might not have the expertise necessary to run the business. It may help to sharpen the focus of management or align the interests of management and share holders. Finally, divestitures transactions might simply be a handy means by which the firm can raise cash that might be greatly needed for things like paying back debt or to fund investment into a more profitable market. A classic example of such a transaction relates once again, to the Kraft Food Group. Recall that in September 2009, it announced a bid for UK confectionary firm, Cadbury. To assist in financing that deal, Kraft sold off its frozen pizza business to Swiss multinational Nestle for $3.7 billion. As you can see from this quote by Kraft to the market at the time of the transaction, Kraft perceived that there were very clear benefits to corporate focus that would result from this transaction. Our next category of corporate restructuring transactions are spin-offs. A spin-off occurs when the parent company establishes one of its business units as a stand alone listed company with shares in that company distributed to parent company shareholders on a pro-rata basis. Do we have an example of such a transaction? Absolutely, and it relates to a company that we're getting to hear a lot about in this course, Kraft Foods. Let's pick up the story a short 18 months following the acquisition of Cadbury. Kraft announces to the market that it's going to spin off its North American groceries business from its global foods business. For each share held at the parent company, shareholders received three shares in the newly established Kraft foods group. The parent company which retained control of the global snacks business was subsequently renamed Mondelez International, which we heard a lot about from Paul Kauffman in the first couple of courses in this broader specialization. So why did Kraft proceed with the spinoff of its North American Groceries business? Well to understand this, we first need to identify just how different these two businesses were in terms of earning streams and growth opportunities. The North American Groceries business was very stable and mature with relatively low growth prospects. In contrast, the global snacks business is really ramping up with great growth opportunities that required lots of funding to enable the firm to take advantage of them. Indeed, the differences in growth opportunities was highlighted by the fact that when spun off from each other, Kraft traded at an EBITDA that is, earnings before interest, tax, depreciation, amortization. And EBITDA multiple of 8 times while Mondelez has traded a multiple of 13 times. The chair and CEO of Kraft at the time Irene Rosenfeld, highlights the need for spinning off in this quote where she claims that the global snacks business was never fully valued by the market when included together with the North American groceries business. Our third type of corporate restructuring transaction is an equity carve out. This is where the company establishes a newly listed entity just like spin off, but this time shares in the entity are sold off to the market with the remaining shares retained by the parent company. So why might firms be attracted to an equity carve-out? Well, unlike a spin-off an equity carve-out provides the opportunity for the firm to obtain much needed funds. So perhaps it's best to view a carve-out as a natural alternative to a straight out divestiture. Interestingly, we find that an equity carve out often precedes a spinoff of the newly established entity. For example, consider the 2014 case of mass media company, CBS announcing a carve out of its outdoor advertising business, CBS Outdoor. When it raised $560 million by listing for sale 19% of the shares in that firm, while retaining the remaining 81% of shares for themselves. Four months later the CBS Outdoor was fully spun off. So as we have seen corporate restructuring transactions are often motivated by a desire to unlock the diversification discount present within multi-segment firms. This discount has been documented to be in the order of 13 to 15% of firm value. The three methods of corporate restructuring covered in this session include divestitures where a firm simply sells off a business unit for cash. Spin-offs which occur when a firm establishes a business unit as a separate listed entity. And then issue shares in that entity to parent company shareholders on a pro rata basis. And finally equity carve-outs which as with spinoffs include the establishment of a separate listed identity but are coupled with an IPO where the funds raised are returned to the parent company. In the fifth and final session of this module, we're going to answer the question how successful are managers in creating value from M&A activity or through corporate restructuring transactions.
