Corporate Restructuring 11 Chapter Corporate Restructuring and Divestitures

Corporate Restructuring Strategies With constantly changing competitive environments, firms must consistently adjust Managers have many options to change firm structure without taking part in a merger or acquisition Corporate restructuring should occur within the framework of the firm’s overall strategy No one-size-fits-all approach to corporate decision making

Types of Restructuring Key methods of reorganizing assets and ownership Type Definition Example Asset sales Sale of division or other assets to another firm, usually for cash Quaker sold Snapple to Triarc (1997) Equity carve-out Public offering of partial interest in subsidiary creating new firm with at least some autonomy Pharmacia carved-out 14% of Monsanto (2000) Spinoff Pro rata distribution of subsidiary shares creating new independent firm Sears spun off Dean Witter Discover (1993)

Types of Restructuring Variations of restructuring and divestiture Type Definition Example Split-up Separation of firm into 2+ parts, often via spinoff HP dividing into HP and Agilent (1999) Tracking stock Creation of new class of stock with value based on cash flows of a division AT&T offering of AT&T Wireless (2000) Exchange offer Distribution giving shareholders choice between parent and subsidiary stock; creates separate public firm Limited’s divestiture of Abercombie &Fitch (1998)

Types of Restructuring Methods are sometimes used in tandem or employed sequentially Equity carve-outs can be first stage of a broader divestiture, preceding: Sale of remaining interest of subsidiary to another firm Spinoff of remaining ownership to shareholders Split-ups employ a variety of methods, usually spinoffs Tracking stock may be first step of a spinoff or exchange offer

Restructuring Example: AT&T has used almost every restructuring method in last 20 years 1984 antitrust break up: split-up using spinoffs Shareholders receive 1 share of each “Baby Bell” for ever 10 AT&T shares AT&T Capital 1993 $107.5 million public offering of 14% 1996 $2.2 billion asset sale to an investor group Spinoff

Restructuring Example: 1995-6 Split-up Lucent: $3 billion carve-out in 18% IPO, followed by spinoff (.324 shares Lucent for each AT&T) NCR: spinoff (0.0625 NCR shares per AT&T) Universal Card: asset sale for $3.5 billion to Citicorp Carve-out, Spinoff Spinoff Asset sale Universal Card

Restructuring Example: AT&T Wireless Tracking stock representing 15.6% interest was sold in IPO for $10.6 billion Later, exchange offer gave shareholders choice of AT&T or AT&T Wireless stock Last, spinoff executed in which .32 wireless shares were distributed to AT&T holders AT&T Broadband 10/00 – AT&T announces it will divest unit 7/01 – Comcast makes unsolicited bid, forcing AT&T into an auction 12/01 – Comcast declared auction winner

More Restructuring Examples Auto Parts Industry GM divested Delphi Automotive Systems (1999) – 17.3% equity carve-out offered in IPO, followed by a spinoff Ford spun off Visteon via a stock dividend Phillip Morris Restructuring to reinforce strategy of focus on food and tobacco Equity carve-out of 16% of Kraft ($8.7 billion) helped pay down debt from Nabisco acquisition Asset sale of Miller Brewing to South African Breweries for $5.6 billion

Restructuring Motives Many possible motives for a firm to restructure Direct relation between corporate strategy and corporate restructuring Corporate focus often cited as restructuring reason, but focused companies also must review strategic alternatives in due to market changes Divestiture reasons: learning, reversing mistakes, changing strategies (Weston, 1989) Firms restructure to remain competitive and to respond to change forces in the economy

Divestitures and Wealth Creation Modigliani, Miller, and Irrelevance If no transaction or information costs, corporate organization is irrelevant Managers cannot improve value by chopping firm into pieces Theory frames analysis of information and transactions costs and other factors

Divestitures and Wealth Creation Theory Research Paper Year Concept of Restructuring Incentives, Monitoring Costs Alchian & Demsetz; Jensen & Meckling 1972; 1976 Improves monitoring function of corp. governance Information, Signaling Myers & Majluf; Nanda 1984; 1991 May signal information known only to managers Transaction Costs Coase; Williamson; Klein et al 1937; 1975; 1978 Response to changes in transaction costs

Restructuring and Transaction Costs: Petrochemical Industry Study of transaction cost uncertainty on vertical integration (Fan, 1996, 2000) Impact of uncertain oil prices: Before 1973 OPEC oil embargo, 13% of sample firms owned oil and gas assets After embargo, fraction increased to over 50% By 1992, fraction reverted back to 26% Consolidation due to energy contracts being difficult to write and to enforce (higher transaction costs) Example: Dupont (chemicals) bought Conoco (oil) in 1981; divested in carve-out and exchange offer in 1998-9

Restructuring and Change Forces: The Natural Gas Industry Change forces transformed industry over course of 100 years Early 1900s – production close to consumers 1920s – gas discoveries in southwest required construction of pipelines – vertical integration between production and transmission 1930s – price regulation, and legislation requiring separation of production and transmission– caused decline in vertical integration Current landscape – changing regulation has encouraged mergers and divestitures