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Split-off, Carve-outs & tracking stock

Mehak Nanda Roll No.14

Split-offs are a type of reorganization where the stock of a subsidiary is offered in exchange for shares in the parent company. In a split-off, the parent company offers its shareholders the opportunity to exchange their ParentCo shares for new shares of a subsidiary (SplitCo). This tender offer often includes a premium to encourage existing ParentCo shareholders to accept the offer.
Example- ParentCo might offer its shareholders $11.00 worth of SplitCo stock in exchange for $10.00 of ParentCo stock (a 10% premium).

If the tender offer is oversubscribed, meaning that more ParentCo shares are tendered than SplitCo shares are offered, the exchange is conducted on a pro-rata basis. If the tender offer is undersubscribed, meaning that too few ParentCo shareholders accept the tender offer, ParentCo will usually distribute the remaining unsubscribed SplitCo shares pro-rata via a spin-off.

Are Split-offs similar to Spin-offs?

A split-off differs from a spinoff, as the shareholders in a split-off must exchange their shares of stock in the parent company in order to receive shares of the subsidiary, whereas the shareholders in a spin-off do not need to trade in their shares in order to receive shares in the subsidiary.

Example of Split-off
McDonalds (MCD) split off of Chipotle Mexican Grill: In September 2006, McDonalds offered to exchange up to an aggregate of 1,65,39,967 shares of Chipotle class B common stock for outstanding shares of McDonalds common stock.

The exchange offer was designed to permit holders of McDonalds common stock to exchange their shares for shares of Chipotle class B common stock at a 10% discount to the calculated per-share value of Chipotle class B common stock.

Meaning thereby, for each $1.00 of McDonalds common stock accepted in the exchange offer, the tendering holder would receive approximately $1.11 of Chipotle class B common stock, based on calculated per-share values.

Equity Carved out

In an equity carve-out, the parent company (ParentCo) sells a portion of its interest(equity stock) in a subsidiary (SubCo) to the public in an initial public offering.
Also known as an IPO carve-out or Split off IPO.

A newly publicly listed company is created, but the parent keeps a controlling stake in the newly traded subsidiary.
Subsidiarys shares are offered for sale for increasing cash inflow.

The management system for operating the assets is likely to be restructured in this new public entity. Financial reports are issued on the subsidiary operations and are studied by financial analysts as reports of a separate entity. A carve-out is a strategic option a parent firm may take when one of its subsidiaries is growing faster and carrying higher valuations than other business owned by the parent.

Company before Equity carve-out

Company A without subsidiary B

Subsidiary B

Stock Market

Company after Equity carve-out

Company A without subsidieary B Portion of Sub B equity Not sold

X % of Company B shares

X % of sub B equity sold To market for cash In IPO

Stock Market

Difference between Equity carve-out & Spin off

Distribution is shareholders company as a non-cash shareholders.

Equity carve-out

made pro-rata to Stock of subsidiary is sold to the of the parent public for cash which is received dividend a form of by the parent company. payment to

Parent company has no longer Parent company generally sell control over the subsidiary assets. minority in the subsidiary(usually 20% or less) and maintain control over subsidiary assets and operations.

GM-Delphi Carve-Out
In 1991 GM organized separate automotive parts operations into the Automotive Components Group with the intent to improve competitiveness and then penetrate new markets.
In 1995, group was renamed Delphi Automotive Systems.

During these years Delphi was able to gain a full understanding of the design, engineering, manufacture and operation of all aspects of the automotive vehicle. Soon Delphi began to transform its business from a captive component supplier to GM to a supplier of components and integrated systems to every major manufacturer of light vehicles in the world. From 1993 to 1998, Delphis sales to customers other than GM grew from 13.3% to 21.4% of total sales.

In 1998, GM board of directors determined that it would be in best interests of all involved to separate Delphi from GM. BODs believed that Delphi would not be able to reach its full business potential with other manufacturers as long as it remained part of GM.
Therefore, Delphi was incorporated in September 1998. In February 1999, Delphi completed its IPO of 1 billion shares of common stock(17.7% equity carve-out) while GM held the remaining 4.65 b(82.3%) of Delphis outstanding stock.

Tracking Stock
Also known as targeted stocks, are a class of parent company stock that track the earnings of a division or subsidiary.

When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent company's financial statements.
It is typically distributed as a dividend shareholders in the parent company. to

Oftentimes, this is done to separate a subsidiary's high-growth division from a larger parent company that is presenting losses. The financial reporting is separate for the TS from the parent but the control remains in the hands of the parent company. Target stock structure does not alter board or director composition or management control of the corporation. Now, TS as a corporate restructuring tool had disappeared altogether.

Example of TS
Several years ago, Sprint had a cell-phone division called Sprint PCS. Because PCS was growing faster than the traditional phone business (affectionately known as Sprint FON to stockholders), it was considered more valuable. So, the company announced that it was going to create a tracking stock so the market could value that particular division as opposed to having it absorbed in the company.

Each Sprint shareholder was given 1 share of PCS for every 2 shares of Sprint FON they owned.

Thus, they traded as two different stocks on the New York Stock Exchange, but PCS was owned by Sprint and only represented a division of its business.

Rationale for sell offs

True value of subsidiary assets is obscured by the complexity of the business structure in which they are embedded. An oil industry analyst may undervalue an oil companys real estate business because he or she does not follow those industries. Spin offs and carve outs enhance the incentive to gather and analyze a greater amount of publicly available information through their creation of new publicly traded securities.

Managerial Efficiency
Inability of the managers to manage organization increases as the size and diversity of assets under their control increases. Top management may be unaware of the unique problems and opportunities of a subsidiary in a different line of business. So motive of sell offs is to sharpen the corporate focus by divesting units that are a poor fit with the remainder of the parent companys operations.

Tax Factors
Tax advantages can be achieved by the creation and spin off of subsidiaries into natural resources royalty trusts or real estate investment trusts. As long as these entities pay out 90% of their income to their shareholders, they pay no income tax. Thus, the parent company can shelter income from taxes and benefit the spun off subsidiarys shareholders, who are the same as the parents shareholders.

Regulatory Factors
Spun-off entity might be under less regulatory constraints than the parent company. AT & T may have decided to spin off its non-phone businesses because regulatory burden under which the phone business operated was constraining its other businesses pursuits as well. Some parent firms have spun off foreign subsidiaries so that they would not subject to the laws and regulations of the home country of the parent.

Bondholder Expropriation
Some spin offs are motivated by the desire to transfer wealth from bondholders to stockholders. In spin offs and split ups, spun off entities often take a share of the debt with them.

Provide investors with pure winners

When some segments of a firm are losing money, the valuation multiple for the overall company may be lowered. Divestures help entities to differentiate between their profitable and nonprofitable businesses. Thus, pressure caused RJR Nabisco to separate its tobacco and food businesses