Deck 16: Alternative Exit and Restructuring Strategies

Question 1

4 How might the form of payment affect the abnormal return to sellers and buyers?

Answer 1

Abnormal returns to sellers are much smaller when the seller receives cash rather than buyer equity. Asset for buyer equity sales generate excess returns of about 10 percent for buyers and 3 percent for sellers. The higher returns for buyers may reflect information communicated to the seller not generally known by the investing public about the synergy between the divested asset and the buyer's operations and the overall future earnings potential of the buyer's business. In contrast, excess returns to sellers receiving cash average about 3 percent for sellers and about zero for buyers.

Question 2

Describe how you as an analyst would estimate the potential impact of the Huntington Ingalls Industries spin-off on the long-term value of Northrop Grumman's share price?

Answer 2

An important stated motivation for the spin-off by Northrop Grumman's management is to simplify the corporation, enable management to focus on those businesses it better understands, concentrate limited investment resources in businesses believed to grow more rapidly than shipbuilding, and to make the firm more easily understood by the investing public. Consequently, it would be necessary to estimate the present value of cash flows with and without Huntington Ingalls. While Northrop Grumman's cash flows would initially suffer from the loss of Huntington Ingall's cash flows, the rate of increase in future cash flows may accelerate. Furthermore, if investors find Northrop Grumman more transparent and less prone to enter the capital markets to finance its former capital intensive shipbuilding operations and hence less risk, the firm's weighted average cost of capital may decline.
Examination Questions and Answers
True/False Questions: Answer True or False to the following questions:

Question 3

is the likely impact of the spin-off on Northrop Grumman's share price immediately following the spin-off of Huntington Ingalls assuming no other factors offset it?

Answer 3

Assuming nothing else changes, the immediate impact on NGC's share price would be to lower it by the amount of the present value of the cash flows of its spun-off shipbuilding business. In practice, the impact is hard to ascertain because of the myriad factors to may impact share price on any given day.

Question 4

do businesses that have been spun off from their parent often immediately put antitakeover defenses in place?

Question 5

deciding to sell a business, a parent firm should compare the business' after-tax value in sale with its pre-tax value to the parent as part of the parent.

Question 6

Divestitures, spin-offs, equity carve-outs, split-ups, and bust-ups are commonly used strategies to exit businesses.

Question 7

9 After months of trying to sell its 81 percent stake in Blockbuster Inc., Viacom undertook a spin-off in mid 2004. Why would Viacom choose to spin-off rather than divest its Blockbuster unit? Explain your answer.

Question 8

Antitrust regulatory agencies may make their approval of a merger contingent on the willingness of the merger partners to divest certain businesses.

Question 9

Speculate as to why Northrop Grumman used a spin-off rather than a divestiture, split-off or split up to separate Huntington Ingalls from the rest of its operations? What were the advantages of the spin-off over the other restructuring strategies.

Question 10

7 On April 25, 2001, in an effort to increase shareholder value, USX announced its intention to split U.S. Steel and Marathon Oil into two separately traded companies. The breakup gives holders of Marathon Oil stock an opportunity to participate in the ongoing consolidation within the global oil and gas industry. Holders of USX-U.S. Steel Group common stock (target stock) would become holders of newly formed Pittsburgh-based United States Steel Corporation. What other alternatives could USX have pursued to increase shareholder value? Why do you believe they pursued the breakup strategy rather than some of the alternatives?

Question 11

8 Hewlett Packard (HP) announced the spin-off of its Agilent Technologies unit to focus on its main business of computers and printers. Hewlett Packard provided Agilent with $983 million in start-up funding. HP retained a controlling interest until mid-2000, when it spun-off the rest of its shares in Agilent to HP shareholders as a tax-free transaction. Discuss the reasons why HP may have chosen a staged transaction rather than an outright divestiture of the business.

Question 12

3 What factors influence a parent firm's decision to undertake a spin-off rather than a divestiture or equity carve-out?

Question 13

10 Since 2001, GE, the world's largest conglomerate, had been underperforming the S&P 500 stock index. In late 2008,
the firm announced that it was considering spinning off its consumer and industrial unit. What do you believe are
GE's motives for their proposed restructuring? Why do you believe they chose a spin-off rather than an alternative
restructuring strategy?

Question 14

1 What are the advantages and disadvantages of tracking or target stocks to investors and to the firm?

Question 15

Empirical studies show that the desire by parent firms to increase strategic focus is an important motive for exiting businesses.

Question 16

6 Explain how executing successfully a large-scale divestiture can be highly complex. This is especially true when the
divested unit is integrated with the parent's functional departments and with other units operated by the parent.
Consider the challenges of interdependencies, regulatory requirements, and customer and employee perceptions.

Question 17

2 How would you decide when to sell a business?

Question 18

timing of a divestiture is important. If the business to be sold is highly cyclical, the sale should be timed to coincide with the firm's peak year earnings.

Question 19

would the U.S. Internal Revenue Service be concerned about a change of control of the spun-off business such that it might revoke its ruling that the spin-off satisfied the requirements to be tax-free?

Question 20

5 How might spin-offs result in a wealth transfer from bondholders to shareholders?

Question 21

Tracking stocks may create internal operating conflicts among the parent's business units in terms of how the consolidated firm's cash is allocated among its business units.

Question 22

Although the parent often retains control in an equity carve-out, the shareholder base of the subsidiary may be different that that of the parent.

Question 23

spin-off is a transaction in which a parent creates a new legal subsidiary and distributes shares it owns in the subsidiary to its current shareholders as a stock dividend.

Question 24

Equity carve-outs have some of the characteristics of both divestitures and spin-offs.

Question 25

spin-off is a transaction involving a separate legal entity whose shares are sold to the parent firm's shareholders.

Question 26

In an equity carve-out, the cash raised by the subsidiary in this manner may be transferred to the parent as a dividend or as an inter-company loan.

Question 27

Voluntary bust-ups or liquidations by the parent firm reflect management's judgment that the sale of individual parts of the firm could realize greater value than the value created by a continuation of the combined corporation.

Question 28

An equity carve-out is often a prelude to a complete divestiture of a business by the parent.

Question 29

The parent firm generally retains control of the business involved in an equity carve-out.

Question 30

Equity carve-outs are similar to divestitures and spin-offs in that they provide a cash infusion to the parent.

Question 31

When a parent creates a tracking stock for a subsidiary, it is giving up all control of that subsidiary.

Question 32

divesting firm is required to recognize a gain or loss for financial reporting purposes equal to the difference between the book value of the consideration received for the divested operation and its fair value.

Question 33

Tracking stocks are often created to give investors a pure play investment opportunity in one of the parent's subsidiaries.

Question 34

Spin-offs are generally immediately taxable to shareholders.

Question 35

a spin-off, the proportional ownership of shares in the new legal subsidiary is the same as the stockholders' proportional ownership of shares in the parent firm.

Question 36

In general, a voluntary bust-up or liquidation has the advantage over mergers of deferring the recognition of a gain by the stockholders of the selling company until they eventually sell the stock.

Question 37

A split-up involves the creation of a new class of stock for each of the parent's operating subsidiaries, paying current shareholders a dividend of each new class of stock, and then dissolving the remaining corporate shell.

Question 38

Both a divestiture and a spin-off generally generate a cash infusion for the parent.

Question 39

a spin-off, the board of directors is the same as the board of directors of the parent firm.

Question 40

a firm is unable to pay its liabilities as they come due, it is said to be in bankruptcy.

Question 41

Divestitures always result in the parent receiving stock or debt from the buyer.

Question 42

Divestitures, spin-offs, equity carve-outs, split-ups, split-offs, and bust-ups are commonly used strategies to exit businesses and to redeploy corporate assets by returning cash or noncash assets through a special dividend to shareholders.

Question 43

Management may sell assets to fund diversification opportunities?

Question 44

A business that is rich in high-growth opportunities may be an excellent candidate for divestiture to a strategic buyer with significant cash resources and limited growth opportunities.

Question 45

A substantial body of evidence indicates that increasing a firm's degree of diversification can improve substantially financial returns to shareholders.

Question 46

Like divestitures or equity carve-outs, the spin-off generally results in an infusion of cash to the parent company.

Question 47

The divestiture of a business always results in the parent receiving cash from the buyer?

Question 48

parent firm's decision to sell or to retain a subsidiary is often made by comparing the after-tax equity value of the subsidiary with the pre-tax and interest sale value of the business.

Question 49

Acquiring companies often find themselves with certain assets and operations of the acquired company that do not fit their primary strategy. Such assets may be divested to fund future investments. True of False

Question 50

The divesting firm is required to recognize a gain or loss for financial reporting purposes equal to the difference between the fair value of the consideration received for the divested operation and its market value.

Question 51

The decision to sell or to retain the business depends on a comparison of the pre-tax value of the business to the parent with the after-tax proceeds from the sale of the business.

Question 52

Managing highly diverse and complex portfolios of businesses is both time consuming and distracting. This is particularly true when the businesses are in largely related industries.

Question 53

In a spin-off, some shareholders receive proportionately more shares than others.

Question 54

a private solicitation, the parent firm may hire an investment banker or undertake on its own to identify potential buyers to be contacted.

Question 55

Many corporations, particularly large, highly diversified organizations, constantly are reviewing ways in which they can enhance shareholder value by changing the composition of their assets, liabilities, equity, and operations.

Question 56

In either a public or private solicitation, interested parties are asked to sign confidentiality agreements after they are given access to proprietary information but before they are asked to make a bid.

Question 57

In a public solicitation, a firm can announce publicly that it is putting itself, a subsidiary, or a product line up for sale. Either potential buyers contact the seller or the seller actively solicits bids from potential buyers or both.

Question 58

Empirical studies show that exit strategies, which return cash to shareholders, tend to have a highly unfavorable impact on shareholder wealth creation.

Question 59

Although the sale value may exceed the equity value of the business, the parent may choose to retain the business for strategic reasons.

Question 60

A parent firm rarely chooses to divest an undervalued business and return the cash to shareholders either through a liquidating dividend or share repurchase.

Question 61

Which of the following is not a characteristic of a spin-off?

A) The parent creates a new legal subsidiary for the business to be spun-off
B) The shares of the new subsidiary are sold to the public
C) The ownership of shares in the new legal subsidiary is the same as the stockholders' proportional ownership of shares in the parent firm
D) The new business once spun-off has its own management and board
E) Spin-offs are generally not taxable to the parent's shareholders if properly structured

Question 62

Parent firms often exit businesses that consistently fail to meet or exceed the parent's hurdle rate requirements.

Question 63

In addition, stock-based incentive programs to attract and retain key managers can be implemented for each operation with its own tracking stock.

Question 64

Although the parent retains control, the shareholder base of the subsidiary that has undergone an equity carve-out is unlikely to be different than that of the parent as a result of the public sale of equity.

Question 65

For financial reporting purposes, a distribution of tracking stock splits the parent firm's equity structure into separate classes of stock without a legal split-up of the firm.

Question 66

spin-off may create shareholder wealth for all of the following reasons except for

A) Spin-offs are generally not taxable if properly structured
B) The spin-off's management and board is independent of the former parent
C) Investors will be better able to value the spin-off
D) The cost of capital of the spin-off is generally higher than when it was part of the parent
E) The spin-off may be subsequently acquired by another firm

Question 67

The reasons for selecting a divestiture, carve-out, or spin-off strategy are basically the same.

Question 68

A disadvantage of a split-off is that they tend to increase the pressure on the spun-off firm's share price, because shareholders who exchange their stock are more likely to sell the new stock.

Question 69

Split-ups and spin-offs generally are taxable to shareholders.

Question 70

decide if a business is worth more to the shareholder if sold, the parent firm generally considers all of the following factors except for

A) The after-tax cash flows of the business to be sold
B) The after-tax sale value of the business to be sold
C) The parent's cost of capital
D) A and B
E) A, B, and C

Question 71

Which of the following is generally considered a motive for exiting businesses?

A) Changing corporate strategy or focus
B) Underperforming businesses
C) Regulatory concerns
D) Lack of fit
E) All of the above

Question 72

Equity ownership changes in spin-offs, but it does not change in split-ups.

Question 73

Divestitures are always taxable to the selling firm?

Question 74

For financial reporting purposes, the parent firm should account for the spin-off of a subsidiary's stock to its shareholders at book value with no gain or loss recognized, other than any reduction in value due to impairment.

Question 75

A spin-off is tax free to the shareholders if it is properly structured. In contrast, the cash proceeds from an outright sale may be taxable to the parent to the extent a gain is realized.

Question 76

In an equity carve-out, minority shareholders are eliminated.

Question 77

A split-up involves carving out a portion of the equity of each of the parent's operating subsidiaries and selling the shares to the public.

Question 78

Unlike a spin-off or carve-out, the parent retains complete ownership of the business for which it has created a tracking stock.

Question 79

Restructuring actions may provide tax benefits that cannot be realized without undertaking a restructuring of the business.

Question 80

Parent firms with a high tax basis in a business may choose to spin-off the unit as a tax-free distribution to shareholders rather than sell the business and incur a substantial tax liability.