We are all familiar with the idea of a spin-off when we are talking about a television series or the movies. Our favorite TV shows sometimes generate other television shows, or our favorite movie spawns additional movies with the same or similar cast of characters.
In the business world, spin-off has a different meaning. A corporate spin-off occurs when a line of business ( often a subsidiary) is placed into a new corporation, with the shareholders of the parent company receiving shares in the new company. Previously the shareholders owned common stock in one company, but now they own stock in two companies. Examples of spin-offs in the corporate world include Vlasic being spun off by Campbell Soup, and Chemours being spun-off off from Dupont.
Why would a company do such a thing? In plain language, a corporate spin-off is something to be considered when the sum of the value of the parts of the corporation exceeds the value of the whole corporation. Let’s look at an actual case study. We will not be discussing the accounting aspects of the transaction, but rather some of the financial considerations. This article is simply a case study of, and not a https://www.lynda.com/Leadership-Management-tutorials/Acting-Decisively/628685-2.htmllete roadmap to a successful spin-off.
Suppose a parent company owns $20 million of marketable securities and a large real estate management company. There are only minor liabilities outstanding. Assume there are 10 million shares of common stock outstanding, at a market price of $1.50 per share. It is readily apparent the stock market is assigning a value to the company less than the cash value per share and totally disregarding the value of the real estate management company. In short, the stock market does not have confidence in the management of the company. The market is expecting the company to dissolutely spend much of the cash and poor operating results from the real estate management company.
This is a clear example of where a corporate spin-off makes sense. Company management determined it would spin-off the real estate management subsidiary. The parent company would then have cash as its only asset, and the real estate company would be operating on its own as a new stand-along entity. Management believed the parent company stock would continue to sell at least at its current discounted cash value, and the newly independent company would also sell at an additional price. Total shareholder value would be increased.
Management did not stop there though. It found another very well-run real estate management company that wished to become publicly traded. The spin-off company was merged into the acquiring real estate company, creating a newly public entity having a market value of several dollars per share. Shareholders saw a jump in total value, and had new management for the operating subsidiary. The parent company then was able to use is investments to secure another operating company and move in a whole new direction. This was a win-win solution for everyone.
What were some of the considerations in accomplishing the spin-off?
- The “carve-out” financial statements needed to be prepared. Carve-out financial statements will be another topic in this series. Suffice it to say for now the SEC requires the financial statements of the spin-off to be stated on a stand-alone basis. For example, any expenses of the spin-off paid by the parent must be included in the financial statements of the spin-off. In this situation, the spin-off was a operated as a totally stand-alone entity, with no support from the parent company. The major accounting issue was the preparation of the tax provision, since the spin-off took advantage of the parent’s net operating losses. Consequently, the financial statement presentation for the spin-off was relatively easy to prepare.
- The spin-off was accomplished in the form of a dividend. Shareholders did not receive a cash dividend, but received the shares of the newly independent company.
- For tax purposes, management needed to value the stock of the spin-off since taxpayers would be taxed on the fair value of the stock being distributed. A dividend distribution is taxable to shareholders only if it is made out of net income. Fortunately, an “earnings and profit” (tax terminology for the ability to pay taxable dividends) study determined the distribution would be tax free, another definite plus for the shareholders.
- The securities of the spin-off was registered with the SEC. At that time, a Form 10 was required.
- Subsequent to the spin-off, a tax-free merger with the second real estate management company occurred. A substantial company, with previously successful management was created with this merger. Shareholders received a shares in a much stronger operating company.
What was the result of these actions? The parent company stock still traded at $1.50 per share, even after the spin-off. The newly independent and merged company did trade at several dollars per share, resulting in a substantial increase in shareholder value. In short, the spin-off, rather than dividing shareholder value, multiplied it! A spin-off is a one arrow in the quiver of management seeking to maximize shareholder value.