Two Mergers Are Better than One

The seldom-used double-dummy structure is trotted out in one of the year's most talked-about deals.
Marie LeoneDecember 1, 2005

Oracle Corp.’s bid to buy Siebel Systems Inc. set Silicon Valley abuzz this fall as gossips gloated over the details of the final chapter in a rivalry that simmered for more than a decade. Siebel founder Thomas Siebel left Oracle in 1990, and three years later started his own firm. For years he has been waging a competitive war against his old boss, Oracle’s Larry Ellison, the brash enfant terrible of the Valley. In recent years, a slump in the software industry has weakened Siebel. Oracle has grown stronger, snapping up faltering competitors in a bold bid to be the titan of the software industry. In September, Oracle pounced on Siebel. Cost of the coup: $5.85 billion.

Was it sweet revenge for Ellison? If so, then Thomas Siebel’s pain was allayed by plenty of money in his pocket. Investment bankers employed a complicated deal structure aimed at minimizing Mr. Siebel’s tax bill. With the help of an arcane but effective tool called the horizontal double dummy, the deal will mean millions in tax savings for Siebel while at the same time offering certain advantages to Oracle. In this transaction, everyone wins — except, maybe, the Internal Revenue Service.

Tax lawyers first devised the double dummy in the 1970s. One of the first big corporate deals to use the strategy was Unilever U.S. when it purchased National Starch and Chemical Corp. in 1978. Robert Willens, a tax and accounting specialist with investment banker Lehman Brothers in New York, calls the device “the most creative structure I have ever seen.” (Lehman investment bankers have advised both acquiring and target companies on six double-dummy deals since 1996, including the 2004 Sears, Roebuck/Kmart merger.)

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Despite the tax advantages, the double dummy has rarely been used, in part because it complicates the corporate structure by creating a permanent holding company at the top. Since 1996, the number of mergers using the structure totals 104, or fewer than 1 percent of the total number of deals, according to Capital IQ, a division of Standard and Poor’s. Still, there have been some very high-profile double-dummy transactions, including Walt Disney’s purchase of ABC/Capital Cities, Berkshire Hathaway’s purchase of General Re, and Time Warner’s purchase of Turner Broadcasting.

Under the terms of the deal announced in September, Oracle is offering $10.66 for each share of Siebel stock. The offer represented a premium of 26 percent over the price Siebel shares were commanding on Nasdaq in September. San Mateo, California-based Siebel had been a highflier — its stock once traded at more than $100 — but it had stumbled in recent years amid weakening demand for its product, software that helps companies analyze sales and customer needs.

In this transaction, the double dummy offers the greatest benefit to Siebel’s large individual shareholders, especially to Thomas Siebel, the single largest individual shareholder. Siebel holds 36.2 million shares, or 7 percent of his company’s common stock. At $10.66 a share, his stake is valued at $386 million. (At the time of the proposed bid by Oracle, he also held an additional 11.2 million stock options.) Siebel likely has a small basis in the stock, having acquired it when the company was launched in 1993.

For him and for other large shareholders that have a small basis, an all-cash buyout would have meant an enormous capital gain. The double-dummy structure provides tax-free treatment on the stock portion of the transaction, which is expected to be finalized early next year.

Top Priority

Clearly, Siebel’s tax bill was a top priority in this deal. In documents filed with the Securities and Exchange Commission, Oracle and Siebel call the tax-free double dummy an “inducement” for Thomas Siebel. Interestingly, in its yearlong buying spree, Oracle has spent billions to acquire 11 companies, including PeopleSoft. Other than Siebel, not one used the double-dummy scheme.

Here’s how a double dummy worked for Oracle and Siebel: First, the companies formed a new holding company. Thus, Ozark Holdings was created. Ozark then created two transitory subsidiaries, the so-called dummies. One will merge with Oracle, the other with Siebel Systems. Oracle and Siebel will survive the double-dummy mergers; the dummy companies will be shut down. Oracle shareholders will exchange their stock on a one-for-one basis, tax free, for stock in Ozark. Siebel shareholders will exchange their stock for cash or stock in Ozark (but no more than 30 percent of the consideration can be stock). Siebel’s shareholders will pay taxes only on the cash portion of the transaction.

The stock portions of the transactions qualify as tax free under Section 351 of the Tax Code, which is not bound by the continuity-of-interest rule of Section 368. However, Ozark must remain in place permanently. Terminating the holding company would jeopardize the tax-free nature of the deal. That’s because Section 351 requires that the tax-free stock transfer between Ozark Holdings and the two operating companies be substantive in nature, notes Mark Boyer, a tax attorney with PricewaterhouseCoopers.

Thomas Siebel could have achieved tax savings on a more common deal structure: a tax-free reorganization under Section 368. But under this structure, Siebel and other shareholders would have had to take at least 40 percent of the compensation in stock. It might have been a good deal for them, but it would have punished Oracle shareholders by diluting earnings per share beyond an acceptable level. Structured as the deal is now, with stock consideration limited to 30 percent of the merger’s total value, dilution of Oracle’s earnings per share will be modest, even if the Siebel stock payout reaches the full 30 percent.

Sometimes, double dummies are built into deals as a sort of safety net. Investment bankers have structured some mergers with a trigger that activates a double dummy under certain conditions. That ensures tax savings in volatile situations, but allows for a simpler deal structure when possible. Witness the $3.1 billion acquisition of Mitchell Energy & Development Corp. by Devon Energy Corp. in 2002. Devon offered a 50-50 cash and stock buyout of shareholders in Mitchell Energy. George Mitchell and his family, who owned 47 percent of Mitchell Energy, insisted that the transaction be structured to ensure that Devon common stock received by shareholders would be tax-free.

Bigger Targets

In its filings, Oklahoma City–based Devon offered a choice of two merger structures: a double dummy or the more commonly used reorganization under Section 368. At the time, points out Devon CFO Brian Jennings, oil and gas prices were falling, and consequently so was the company’s stock price. If Devon’s stock price had dropped before the reorganization was complete, the 40 percent equity-consideration threshold might not have been met and shareholders receiving stock, including the Mitchell family, would have been taxed immediately on the receipt of Devon stock. That’s why Devon proposed a double dummy as a hedge. Ultimately, Devon and Mitchell never had to use the double dummy.

Delaware recently made it easier for companies incorporated within the state to expedite a double dummy with changes in state law. Delaware no longer requires stockholder approval for the “sale, lease, or exchange” of corporate assets between a parent company and its subsidiaries. Ozark Holdings is a Delaware corporation.

Marie Leone is senior editor of

Big Dummies
A list of the largest double-dummy transactions by deal value includes some of Wall Street’s most memorable mergers.
Year Merger Partners Deal Value*
2000 AOL/Time Warner $164
2000 SmithKline Beecham/Glaxo Wellcome 80
1998 Daimler-Benz/Chrysler 61
2001 Conoco/Philips Petroleum 27
2004 Kmart/Sears, Roebuck 20
*In $ billions
Source: Capital IQ