LBOs, Spin offs and Equity

Carve-out

Spin offs

Typically parent corporation distributes on pro rata basis,

all the shares it owns in subsidiary to its own
shareholders.
No money generally changes hands
Non taxable event
as long as it jumps through substantial hoops

Spin offs

Company A without Subsidiary B

Company before spin off

Subsidiary B

Shareholders
Shareholders own shares of combined company. Own the equity in subsidiary implicitly.

Spin offs (2)

Company A after spinoff

Shareholders
receive
Shares of
company B

Company after spin off

New company B

Shareholders

Old shareholders still own shares of company A, which now only represent ownership of
A without B.

Central features of spin offs

Spin offs are a distribution of subsidiary shares to parent

company shareholders
As such, no money (necessarily) comes into the parent
company as a result
No shares (or assets) of the subsidiary are sold to the market
(IPO) or to acquirer (divestiture)

Distribution in most instances is tax free

Some recent spin offs

Pepsi/Tricon
Pepsi originally wanted to establish a captive channel
for fountain beverage business, but found they
needed to alleviate competitive barriers to expanding
that business (many more restaurant chains)

Whitman Corporation/Hussman/Midas
Conglomerate discount, conflicts among management
of divisions
No synergies between bottlers/heavy industry/auto
service

RJR/Nabisco Holdings
Tobacco litigation, discounting food company
Carl Icahn, Bennet Lebow
6

Equity carve outs

Also called partial IPO

Parent company sells a percentage of the equity of a
subsidiary to the public stock market
Receives cash for the percentage sold
Can sell any percentage, often just less than 20%, just
less than 50%, are chosen.

Equity carve out (partial IPO)

Company A without subsidieary B

Company before carve out

Subsidiary B

Stock market
Shareholders
Shareholders implicitly own 100% of equity of subsidiary B through their Company A shares.

Equity carve out (partial IPO)

Company after carve out
Company A without subsidieary B

Portion of
Sub B equity
Not sold

X % of sub B equity sold

To market for cash
In IPO
X % of
Company
B shares

Shareholders
Shareholders now own 100% of Company A (without B)
And (1-X)% of Company B implicitly
Through their company A shares

Stock market

Motivations for transactions

Market for corporate control
Asset are more valuable to alternative
management team
Divestiture, spin off, carve out, tracking stock

Unlocking hidden value

Stock market problem or management problem?

Improving management incentives

Divestiture, spin off, carve out, tracking stock

Agency costs
Divestiture, spin off, carve out, tracking stock

10

Leveraged Buyout

Small group of investors borrows money to buy the

stock of a public corporation.
LBO transaction is expected to be reversed with a public
offering within three to five years.
Sometimes only a segment, a division or subdivision of
the firm is bought.

Management

Buyout:
An LBO where management plays a significant role.

Buyin:
An LBO where outside management plays a significant role.

LBO and MBO Sponsors

Leveraged buyout specialist (KKR)

Venture capitalists
Investment bankers

FORBES TOP 25 PRIVATE COMPANIES

Source: www.forbes.com

THE 25 LARGEST LBOs, Jan 2000 - Dec

2003
Source: Securities Data Corporation
Date
Announced

Target Name

Target Industry Sector

Target
Nation

Acquiror Name

Acquiror
Nation

29-Jul-02
11-Jun-03
4-Sep-03
20-Aug-02
6-Oct-03
2-Oct-00
17-Oct-03
17-Jun-02
26-May-01
23-Jun-00
8-Mar-02
12-Sep-03
20-Mar-02
22-Feb-00
20-Aug-02
25-May-01
24-Nov-03
29-Jun-01
12-May-03
3-Jan-01
7-Aug-00
20-Mar-01
28-Jan-03
12-Sep-01

Legrand SA
Seat Pagine Gialle-Directories
Ondeo Nalco Co
Qwest Commun Intl Inc-QwestDex
Scottish & Newcastle-Ret Bus
IBP Inc
Chelsfield PLC
Jefferson Smurfit Group PLC
Yell Group
Johns Manville Corp
Southern Water(Scottish Power)
Debenhams PLC
Unique Pub Co,Voyager Pub Co
Deutsche Telekom AG-North
Qwest Comm Intl-QwestDex
Le Meridien Hotels
Warner Music Group
Eircom PLC
Debenhams PLC
Messer Griesheim GmbH
VEBA Electronics Inc(VEBA AG)
Fairbar Ltd
Deutsche Telekom-Cable TV Cos
Cognis BV(Henkel KGaA)

Electronic and Electrical Equipment

Printing, Publishing, and Allied Services
Chemicals and Allied Products
Printing, Publishing, and Allied Services
Food and Kindred Products
Food and Kindred Products
Investment & Commodity Firms,Dealers,Exchanges
Paper and Allied Products
Printing, Publishing, and Allied Services
Stone, Clay, Glass, and Concrete Products
Electric, Gas, and Water Distribution
Retail Trade-General Merchandise and Apparel
Retail Trade-Eating and Drinking Places
Radio and Television Broadcasting Stations
Printing, Publishing, and Allied Services
Hotels and Casinos
Electronic and Electrical Equipment
Telecommunications
Retail Trade-General Merchandise and Apparel
Chemicals and Allied Products
Wholesale Trade-Durable Goods
Retail Trade-Eating and Drinking Places
Radio and Television Broadcasting Stations
Chemicals and Allied Products

France
Italy
United States
United States
United Kingdom
United States
United Kingdom
Ireland-Rep
United Kingdom
United States
United Kingdom
United Kingdom
United Kingdom
Germany
United States
United Kingdom
United States
Ireland-Rep
United Kingdom
Germany
United States
United Kingdom
Germany
Netherlands

Investor Group
Silver SpA
Investor Group
Investor Group
Spirit Amber Bidco Ltd
DLJ Merchant Banking Partners
Duelguide PLC
MDP Acquisitions
Investor Group
Investor Group
First Aqua Ltd
Baroness Retail Ltd
Investor Group
Investor Group
Investor Group
Grand Hotels(M)Acquisition Co1
Investor Group
Valentia Group
Laragrove Ltd
Investor Group
Investor Group
Shopgood Ltd(Morgan Grenfell)
Investor Group
Investor Group

France
United Kingdom
United States
United States
United States
United States
United Kingdom
Ireland-Rep
United Kingdom
United States
United Kingdom
United Kingdom
United Kingdom
United States
United States
United Kingdom
United States
Ireland-Rep
United Kingdom
Germany
United States
United Kingdom
United Kingdom
Germany

Value of
Transaction
($mil)
5,059.72
4,367.53
4,350.00
4,300.00
4,173.88
3,766.98
3,413.40
3,315.01
3,043.08
3,028.45
2,927.61
2,912.78
2,865.91
2,784.61
2,750.00
2,675.96
2,600.00
2,560.70
2,492.84
2,467.96
2,350.00
2,327.98
2,282.29
2,266.00

THE 25 LARGEST LBOs, 19802003

LBO Financing
Secured Debt
Secured debt is also called asset-based lending, and it can
be either senior or intermediate term debt.

Senior Debt
Comprises loan secured by liens on particular assets of the
company.
The collateral includes physical assets such as land, plant
and equipment, accounts receivable, and inventories.
Lenders will usually advance 85% of the value of the accounts
receivable and 50% of the value of the target inventories.

The process of determining the collateral value of

the LBO candidate's assets is sometimes called
qualifying the assets.

LBO companies
remain private
only for a few
years.

Financial Acquirers
(LBOs) negotiate
better than
Corporate Acquirors
(Mergers & Tender
Offers).

Intermediate Term Debt

Is usually subordinate, and often backed up by fixed

assets such as land and plant and equipment.
The collateral value of theses assets is usually based on
their liquidation value.
Debt backed up by equipment typically has a term of six
months to one year.
Loans backed up by real estate tend to have a one- to
two-year term.

Unsecured Debt Financing

It is usually referred to as subordinated and
junior subordinated debt.
The term mezzanine layer financing is often
applied to this financing because it has both
debt and equity characteristics: it is equity
like in that lenders typically receive warrants
that may be converted into equity in the
target.
When the warrants are exercised, the share
of ownership of the previous equity holders is
diluted. It is important to be aware of the
role of the warrants in computing the return
to the providers of mezzanine layer financing.

Buyout Benefits
Tax savings
Stepped up asset base.
Approximately half of the companies involved in LBOs
stepped up their asset base in 1980's (Kaplan, Journal of
Financial Economics, 1989)

Tax shields from interest payments.

One should realize, however, that these benefits should
be relatively low when all of the costs and benefits are
factored in. Most likely the LBO companies do not have
the optimal capital structure in the first few years after
the LBO - why would they otherwise not keep those high
debt levels?
The next two tables are from Kaplan, S. (1989), Management
Buyouts: Evidence on Taxes as a Source of Value, Journal of Finance,
611-632.

THE END!