3.4 Corporate Restructuring via Spinoffs, Divestitures and Equity Carve-outs

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En provenance du cours de The University of Melbourne

Corporate Financial Decision-Making for Value Creation

262 notes

The University of Melbourne

Corporate Financial Decision-Making for Value Creation

262 notes

Cours 3 sur 5 dans Specialization Essentials of Corporate Finance

In this course, participants will learn about the key financial decisions modern corporations face, as well as the alternative methods that can be employed to optimize the value of the firm’s assets. This is part of a Specialization in corporate finance created in partnership between the University of Melbourne and Bank of New York Mellon (BNY Mellon).

À partir de la leçon

Creating Value via Takeovers, Mergers and Corporate Restructuring

During week 3 we will explain how takeovers and mergers occur in practice, define the key terms used in the analysis of markets for corporate control and then develop an understanding of how changes in control might be objectively assessed via financial analysis. In addition to answering the question “how might we create wealth through growth?” we will also consider how value might be created by getting smaller in our review of the impact of corporate restructuring on shareholder wealth.

3.0 Welcome and Introduction6:34

3.1 The Anatomy of an Acquisition7:22

3.2 The Financial Evaluation of a Takeover12:51

3.3 Establishing the Economic Rationale for Takeover Activity12:25

3.4 Corporate Restructuring via Spinoffs, Divestitures and Equity Carve-outs8:39

3.5 Empirical Evidence of the Wealth Impact of Mergers, Acquisitions and Corporate Restructuring10:09

Rencontrer les enseignants

Paul Kofman
Dean, Faculty of Business and Economics
Sidney Myer Chair of Commerce
Sean Pinder
Associate Professor
Faculty of Business and Economics

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.

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