VideoTwo years ago, when Eastman Chemical Co. first considered a restructuring to resuscitate its sagging stock price, a spin-off wasn't even on the radar screen. "Company loyalty was very much in vogue, and there was a sense that we could make a reorganization work in the form we were in," says senior vice president and CFO James Rogers.
But a spin-off quickly emerged as the sensible way to go. For one thing, separating its two main businesses, specialty chemicals and polyethylene terephthalate (PET) plastics, made organizational sense. A rush of competitors into the production of PET resins had turned it into a commodity-style operation, with its own marketing and capital- raising needs, and with a different investor appeal. Also, the company was intimately familiar with the spin-off form: Eastman Chemical itself was born in a spin seven years ago, when Eastman Kodak Co. divested itself of a range of nonphotographic businesses by issuing stock in a new company to Kodak shareholders.
Indeed, Eastman Chemical not only understood the appeal of avoiding taxes through a qualifying spin-off, but it also appreciated the fact that unlike the taxable outright sale of a unit, "there's no other [buying] party you have to work with," as Rogers points out. "The spin is in your control, as long as you handle things well with the Internal Revenue Service." All these factors led Eastman to announce last February that it would split into two new companies via a spin-off (more on this deal below).
During the long bull market, spin-offs became common. They were prized as a tax-free way to squeeze cash out of hot dot-coms, or to package unattractive assets for investors seemingly poised to buy anything. Today, though, the spin-off once again is viewed as a basic tool for allowing noncore businesses to grow by giving them a separate identity and attracting investors.
As a type of divestiture, in fact, the spin-off has been quite resilient over the past 18 months, spiking last year at a near-record volume of $92.3 billion. Through June 30, companies had spun off eight companies of more than $500 million in size, worth a total of $43.6 billion.
"To the extent that spin-offs are consummated to unleash value, they become even more popular in down markets," says Gregory Falk, a mergers- and-acquisitions tax partner at Pricewaterhouse-Coopers LLP. Companies hope, of course, that the purer plays resulting from a spin-off will fare better with investors than one stock representing the combined businesses. Also, the tax benefits of a spin-off "ring true in a strong or a weak stock market," adds Falk. Those benefits are avoidance of the 35 percent federal tax on the unit being divested, as well as of the income tax liability for stockholders that receive the qualified spun- off shares.
Meanwhile, the popularity of one species of spin-off, the carve-out, has suffered somewhat. That's because carve-outs make shares available through an initial public offering as opposed to a shareholder dividend, and therefore depend on a healthy IPO market.
THE TWO "S" WORDS
Experts see little reason for a letup in spin-offs, in part because companies will be looking for ways to unravel the tangles brought on by the merger binge of the 1990s. J. Randall Woolridge, a finance professor at Pennsylvania State University, says that many companies like to predict the synergy that will be achieved through an acquisition, but "the other 'S' word that they don't talk about is spin- off. And when one 'S' word doesn't work out, the other one does."
Correcting a merger miscalculation was at the root of a recently completed spin by Equifax Inc. The Atlanta-based information services concern, with annual revenues of about $1.2 billion, announced last October that it would shed its $780 million payment services business, now called Certegy Inc. When Equifax acquired the business in 1988, "the thought had been that each company could incorporate the other's businesses, but they were two very distinct businesses, with few operating synergies," says Equifax executive vice president and CFO Phil Mazzilli. Now, Equifax has learned that "smaller companies can move more quickly, and each of the companies will grow faster separately than they would together."
The biggest boost from a spin-off may well stem from the psychological lift it gives employees of the newly divided companies, says Woolridge: "There's this tremendous entrepreneurial spirit, especially in the higher-growth units." Executives are energized by the prospect of stock options and other compensation geared to operations of the reorganized units. And operationally, spun-off companies can be a lot easier to manage. "There's much less having to play politics for capital," notes Woolridge.
Investors also like it when companies announce spin-offs, according to a recent report by J.P. Morgan Securities Inc. The report says parent firms making such divestiture plans outperform the market by around 5 percent, on average, with big spin-offs producing larger share- price increases. The spun-off outfits themselves, in the first 18 months of independent operation, outperform the market by an average of more than 10 percent, says the report.
NEW CHEMISTRY
Reader Comments» Post a comment