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My Boulder for Your Cat's Eye

When swapping assets makes more sense than buying or selling them.
Emily S. Plishner, CFO Magazine
December 1, 1997

If you've never considered swapping an asset instead of selling it, you aren't alone. Asset swaps are hardly the stuff of everyday corporate finance.

But the concept is familiar to anyone who has ever traded marbles or baseball cards. You have something I want badly and I have something you want badly, so we trade. And in the corporate version of this game, asset swaps offer a big advantage to would-be sellers over traditional divestitures: There's no tax on any appreciation in the value of the asset swapped away, if done by the rules. Would-be buyers have a different advantage: Sometimes they can tease out an asset that the other party would not otherwise have been willing to sell--if they're willing to give up something the other party really wants.

When asset swaps do occur, they happen in bunches, usually as a result of industry consolidation. The radio business, for example, has seen a slew of such deals, with one swap after another reshaping the industry. Following the Federal Communications Commission's gradual relaxation of its rules on the number of stations that can be held by one owner in the same geographic market, radio station operators have been "clustering" their properties through swaps.

Another industry that has seen a lot of swaps recently is cable television. After the initial franchises were let some 15 years ago, operators discovered that there were considerable economies in operating contiguous systems, rather than having them scattered all over the map. In some midsized metropolitan areas, as many as 50 different operators might be fragmenting the market, community by community. The solution? Swapping franchises to spread fixed costs over more subscribers.

SO MANY PLANETS,SO LITTLE TIME
Other recent deals have involved educational publishing (McGraw-Hill with Times-Mirror), hospitals (Columbia/HCA with Community Health Systems), chemicals (Witco with Ciba Specialty Chemicals), and auto parts (Cooper Industries with Standard Motor Products). All of these industries are undergoing consolidation of one kind or another.

Granted, asset swaps are not likely to replace straight acquisitions and divestitures as the most common form of dealmaking. For one thing, swaps require too many financial planets to line up perfectly to work. Also, swaps by nature are more a means of rationalizing existing business than of exploiting new opportunities. Even Telecommunications Inc. (TCI), the Denver-based media giant that does as many swaps as any company, sees them as a less-important financial tool than joint ventures or acquisitions for that reason. "We're an operating company, not a trading company," notes Bernard Schotters, treasurer and senior vice president of finance at TCI. But while numbers are hard to come by, anecdotal evidence suggests that an increasing number of companies find swaps preferable to other kinds of transactions when circumstances are right.

Asset swaps aren't all that complicated in structure. You can't swap intangible assets-- which rules out whole companies. Also, the assets involved have to be "like-kind," which is usually interpreted to mean that they're in the same four-digit standard industrial classification under the Commerce Department's reporting system (known as the SIC code). While the SIC code rule is conventional wisdom, there is plenty of room for interpretation here, and your tax lawyers and accountants should be the final arbiters for whether assets qualify. This can be exponentially more complicated if the deal is cross-border, because of differing tax regimes and the fact that the SIC code doesn't apply abroad.

TAX SAVINGS AREN'T EVERYTHING
Most people who have structured asset swaps will tell you that swaps are not really tax- driven. They contend that most are driven by strategic considerations, with the tax advantage only the gravy. In fact, it sometimes makes sense to do a swaplike transaction even if it's not tax free. Peter Young, a principal at Young & Partners LLC, a New York­based investment banking firm specializing in chemical- and pharmaceuticals- industry deals, says that he has seen "swaps" that are really "simultaneous, contingent sales." Here the tax advantage is limited to the party's ability to assign a low value to the exchanged assets, which reduces the size of any capital gains.

But clearly, bigger tax benefits were a significant bonus for radio-industry swaps. The market value of many radio stations had appreciated substantially. While their owners wanted the economic efficiencies that could be gained by clustering in the same market, they were unwilling to sell if they had to pay an enormous capital gains tax on the sale. By swapping radio station for radio station, they realized both strategic and tax benefits.

Cable deals are no less tax-driven, says Jimmy Hayes, CFO of Cox Communications Inc., a telecommunications company and cable TV operator based in Atlanta. "A lot of people won't sell you a [cable] system, because they don't want to pay the taxes," says Hayes.

Although there aren't many reliable figures on how many are done and what their value is, Lehman Brothers Inc. accounting analyst Robert Willens says swaps are most popular with "entrepreneurial types in California. Public corporations don't do it all that often." And when they do, the value of the deal is rarely disclosed.


If swaps aren't that complex and they yield such juicy tax benefits, why are they so rare? Because perfect matches are required, and they aren't easy to find. Much more is involved than there would be for an acquisition and divestiture of any two assets to different parties. True, one side or the other sometimes kicks in a cash "boot" to balance out the values, but that undermines the tax benefit since any part of the deal in cash is taxable as a long-term capital gain.

Consider TCI. In the past several months, for example, the company has announced three swaps; and 14 joint ventures, affecting 3.5 million customers in markets that represent about 5 million homes, according to Schotters (see chart, left). But TCI has done even more joint ventures because they enable TCI to retain customers that would otherwise be lost, and they are easier to arrange.

TWO TO TANGO
TCI isn't alone. Other companies find it more difficult to come to terms in swaps than in traditional transactions, simply because a second asset is involved. As David O'Hayre, senior vice president for investment at Time Warner Cable, in Stamford, Connecticut, puts it, swap negotiations often lead to a "my child's prettier than yours" scenario. So O'Hayre notes that even fewer swaps than straight transactions work out if one party is "only lukewarm" about the deal.

Yet the valuation models used by companies swapping assets work much as they would for a regular divestiture. And because most of these deals happen between companies that are familiar with each other's assets, they usually can skip the normal expense of bringing in a financial intermediary to help.

Some companies will take a property in a swap that they intend to use as a bargaining chip in another swap. But it's risky for an operating company to accept a property it intends to trade away, unless it can run it profitably if the next deal doesn't work out. Investment bankers say some cable and radio companies have taken that risk without much assurance on that score, although the bankers decline to identify them.

Another risky variation involves something known as a deferred swap. Here a company can swap for a property it wants by offering a property it doesn't own but intends to buy for the purpose. A deal announced this past August 26 between Paxson Communications Corp., a diversified media company in West Palm Beach, Florida, and Clear Channel Communications Inc., another diversified media company, in San Antonio, that involved radio stations and networks as well as outdoor advertisement displays, worked this way. In such deals, however, the property to be swapped away has to be put into a trust, the trustee has 45 days to locate the asset to be swapped for, and the transaction has to be completed within 180 days. So if either party doesn't complete its end of the deal within these time periods, all bets are off.

For that reason, expect the more exotic types of swaps to remain rare. Yet conventional deals may become more common, as other industries consolidate. The electric utility business is a natural candidate, with deregulation fueling competition.

And if the current focus among most firms on core competency continues, look for more deals that have to do with products rather than geography. Indeed, product-line clustering drove Cooper Industries's recently announced trade of its Moog Automotive's temperature- control product lines, for Standard Motor Products's brake business, which is closer to Cooper's wheel-oriented core business. Much the same kind of product rationalization inspired Witco's deal with Ciba.

Where else might you see such swaps? In any industry in which companies have a large array of products and considerable overlap among customers and suppliers.




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