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A "Public" LBO for Clear Channel

In an unusual and clever move, Clear Channel shareholders – if they choose, will become part of a so-called two corporation merger.
Robert Willens, CFO.com | US
June 9, 2008

Clear Channel Communications Inc. recently announced that the company, the sponsors of its long-running leveraged buyout, and the financiers of the LBO, have entered into a settlement agreement with respect to various lawsuits filed in New York and Texas related to the buyout. The settlement agreement envisions an alteration of some of the details of the previously-announced merger while retaining its basic contours.

At the end of the day, this particular LBO will be unlike any other we have observed in recent years: In this transaction, the public shareholders of the target (Clear Channel) will be afforded an opportunity to become part of the "sponsor group" because such public shareholders will be permitted, if they so elect, to acquire up to 30 percent of the stock of the new corporation formed to effect the buyout.

"Two Corporation" LBO
In the words of authors Professor Martin Ginsburg and Mr. Jack Levin, the transaction will be structured as a so-called "two corporation LBO." (See Ginsberg and Levin, Mergers, Acquisitions and Buyouts, Paragraph 14.02.) As a result, the sponsors — Bain Capital Partners and Thomas H. Lee Partners &#8212l will form a new company via a reverse merger, called CC Media Holdings, Inc. (CCM), and the new company will obtain equity financing.

To be sure, CCM will form a subsidiary (Mergerco) and Mergerco will procure debt financing, and immediately thereafter, merge with and into Clear Channel. The old Clear Channel shareholders, in turn, will receive in exchange for their stock, a combination of cash and shares of CCM. The total number of Clear Channel shares that may elect to receive shares in CCM will make up 30 percent of CCM's equity and is expected to be approximately 30 million shares, , according to a press release issued by the company.

These shares will have a total value of approximately $1.1 billion. The terms of the amended merger agreement provide that no shareholder (of Clear Channel) will be allocated more than 11,111,112 shares, representing an estimated 11 percent of the outstanding capital stock of CCM immediately following the closing of the merger. In limited circumstances, the Clear Channel shareholders who elect to receive some or all cash consideration, on a pro rata basis, will be issued shares of CCM in exchange for some of their Clear Channel shares up to a cap of $1 per share.

For tax purposes, here is how the transaction will be viewd: To the extent Mergerco borrows the funds to pay off Clear Channel's shareholders (such that Clear Channel becomes liable for such debt upon the merger of Mergerco into Clear Channel), the transaction will be treated as a redemption by Clear Channel of its stock. (See Ginsburg and Levin, supra and Revenue Rule 78-250, 1978-1 C.B. 83.) Further, to the extent that CCM borrows money or raises equity capital to pay off Clear Channel's shareholders, the transaction will be treated as an acquisition — by CCM of Clear Channel's stock by means of purchase.

Finally, with respect to the exchange of Clear Channel stock for CCM stock, the exchanging Clear Channel shareholders should be treated, together with the sponsors, as incorporators or founders of CCM. As a result, no gain or loss should be recognized with respect to the disposal of that portion of their Clear Channel stock based on Section 351 of the tax code .

In every case, the redemption element of the transaction should qualify for "exchange" treatment. Consider the elements of the deal in that respect. The shares exchanged for the cash will be treated as redeemed by Clear Channel. Further, the cash is attributable to the borrowing by Mergerco for which Clear Channel, as a result of the reverse merger, becomes liable. In addition, the deal's cash should not be characterized as a "distribution of property" under Section 301 of the tax code.

The redemption qualifies for exchange treatment because each shareholder of Clear Channel — including those shareholders who exchange a portion of their Clear Channel stock for CCM stock — will have completely terminated his or her proprietary interest in Clear Channel. A redemption is treated as a distribution in part or full payment in exchange for the stock redeemed when the release of stock is, within the meaning of Section 302(b)(3), in complete redemption of all of the stock owned by the shareholder.

Here, no shareholder of Clear Channel, not even those who receive stock in CCM in exchange for a portion of their Clear Channel stock, will have an "interest" in Clear Channel after the transaction is completed. This is so because a shareholder of a corporation (CCM) is deemed to own stock owned by that corporation only if the shareholder owns, actually and constructively, at least 50 percent, by value of the corporation's stock. (See Section 318(a)(2)(C) and McDonald v. Commissioner, 52 T.C. 82 (1969.)


In this case, no Clear Channel shareholder will own an amount of stock of CCM which even approaches the 50 percent threshold. Therefore, each redeemed shareholder will be viewed as having terminated his or her proprietary interest in Clear Channel. Accordingly, as provided in Section 302(b)(3), each such shareholder will enjoy exchange treatment with respect to the redemption phase of the transaction. Thus, the basis of the Clear Channel shares deemed surrendered in this phase of the transaction will be compared with the redemption proceeds. As a result, the excess value of the proceeds over the value of the surrendered shares will constitute capital gain income for each such redeemed shareholder.

A former Clear Channel shareholder who exchanges the balance of her Clear Channel stock exclusively for CCM stock will recognize no gain or loss on the exchange, as the exchange should be governed by Section 351(a) of the tax code. That section provides that no gain or loss shall be recognized if property is transferred to a corporation (CCM) by one or more persons (the sponsors and the exchanging Clear Channel shareholders) solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control — within the meaning of Section 368(c) — of the corporation.

That will be the case here, since collectively, the sponsors and the exchanging shareholders (the persons transferring property to CCM in exchange for its stock) will be in control of CCM immediately after the exchange. Accordingly, the exchanging shareholders will be able to avail themselves of the non-recognition of gain benefits of Section 351.

The situation is different if an old Clear Channel shareholder exchanges her Clear Channel shares, and the shares are not treated as having been redeemed for a combination of Clear Channel stock and cash. Then, the shareholder will be governed by Section 351(b)'s "boot" rule. That means, the shareholder's gain from the exchange will be recognized, but in an amount not in excess of the cash received. (The shareholder's gain is defined as the amount by which the sum of the value of the CCM stock and the cash received exceeds the basis of the Clear Channel surrendered.)

However, even when boot is received in an exchange that otherwise qualifies under Section 351, no loss may be recognized. The cash, in that case, will not be treated as received in redemption of CCM's stock because the transaction is not governed, in whole or in part, by the provisions of Section 304. It will not be so governed because the old Clear Channel shareholders, taken together, will not own as much as 50 percent of CCM's stock, by either voting power or value. Accordingly, the transaction will not be treated as a redemption of stock through the use of a related corporation. Therefore, the transaction's status as a Section 351 exchange will not be usurped by the provisions of Section 304(b)(3)(A), which holds that when a transaction is described in both Section 304 and Section 351, the former will apply to characterize any property (other than stock) received in the transaction.

No "QSP"
Finally, it should be noted that CCM will not be in a position to execute an election under Section 338(g) with respect to its acquisition of Clear Channel's stock. Therefore, CCM will not be able to enjoy a "cost" basis with respect to Clear Channel's assets and instead, will hold those assets at the same basis at which they were held by Clear Channel.

No election is possible here — and, in fairness, even if an election was permissible it would probably not be made in light of the large upfront tax costs associated with such an election — because CCM's acquisition of Clear Channel's stock will not constitute a qualified stock purchase. Stock acquired in an exchange to which Section 351 applies is not acquired by purchase. So presumably, more than 20 percent of Clear Channel's stock will be so acquired by CCM. (See Section 338(h)(3)(A)(ii).)

Accordingly, there can be no qualified stock purchase. That's because that term describes a transaction, or series of transactions taking place within a 12 month period, in which the acquiring corporation (CCM) purchases the amount of target stock specified in Section 1504(a)(2) — at least 80 percent of the target's stock, by both voting power and value.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.




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