Chapter 15 – Alternative Restructuring Strategies 1

Divestitures Sale of a portion of the firm to an outside party generally resulting in a cash infusion to the parent. Most common restructuring strategy. Motives: –De-conglomeration / Increasing Corporate Focus –Moving away from the core business –Assets are worth more to the buyer than to the seller –Satisfying government requirements – anti trust –Correcting past mistakes –Assets have been interfering with profitable operation of other businesses 2

“Divestitures in Difficult Times” ¹ “Divestitures will increase, more complex.” 215 execs – public ( 1/4 ), private ( 1/2 ), PE/VC ( 1/4 ) Buyer’s Market – 60%; 30% buyers, credit crisis Companies positioned to buy or sell or to buy Most complex issue with divesture: –Separate business – 23% (Public company issue) –Carve out financials; recast historical #s – 21% –Find buyer – 25% (Private company complaint) –Negotiate contract – 10% –Execute deal in short time frame – 18% ¹ PricewaterhouseCoopers, Divestitures in Difficult Times: Survey of US Executives … Drivers and Challenges for 2010 and Beyond 3

“Divestitures in Difficult Times” ¹ How much longer to divest? –20 % longer – 51% –More than 10%, less than 20% - 21% More Buyer due diligence last 12 months? –32% extensive additional information –43% additional information –25% same as prior years Valuation expectation difference – 50% ? 4

Divestitures in Difficult Times” ¹ Audited financial statements important? –Critical to get deal done or max value – 27% –More important in current market – 49% –If buyer has financing requirements – 16% Consider alternatives if no traditional deal? –Seller financing – 20% –Joint venture or other – 18% –Consider all options- 27% 5

Breaking Up Is Hard To Do IT Integration makes divestiture difficult Support services & facilities hard unravel Outsourcing adds third party issues Divested entity needs long term support Disruption issue - seller & divested entity May impact seller’s cost structure. Margin. Regulators may force your hand DOJ/SEC ¹. Booz Allen, Chief Executive Magazine, 2009, Seven Reasons Divestitures Are Harder Than You Think 6

Deciding When to Sell: Financial Evaluation of Divestitures – With/WO 1.Estimate unit’s after-tax cash flows viewed on a standalone basis, carefully considering dependencies with other operating divisions 2.Determine appropriate discount rate 3.Calculate the unit’s PV to estimate market value 4.Calculate the equity value of the unit as part of the parent by deducting the market value of liabilities 5.Decide to sell or retain the division by comparing the market value of the division (step 3) minus its operating liabilities (step 4) with the after-tax proceeds from the sale of the division. 7

Potential Seller Reactive Sale Proceed to Negotiated Settlement Pursue Alternative Bidders Public Solicitation Private Solicitation Proactive Sale Public Solicitation Private Solicitation The Selling Process 1.Qualified bidders sign non-disclosures 2.Submit non-binding bids in range 3.Bids ranked by: Terms, ability to finance, ease of closing 4. Submit binding bids 8

Spin-Offs ¹ & Split-Ups Spin-Offs: New legal subsidiary created by parent with new subsidiary shares distributed to parent shareholders on pro-rata basis (e.g., Medco by Merck in 2004) Spinoff Report - Berkshire –Shareholder base in new company is same as parent –Subsidiary becomes a publicly traded company –No cash infusion to parent –Tax-free to shareholders if properly structured Split-Ups (e.g., AT&T in 1985): –A new class of stock is created for each of the parent’s subsidiaries –Current parent shareholders receive a dividend of each new class of stock, –Sometimes the remaining corporate shell is dissolved ¹ and DIVISION OF CORPORATION FINANCE SECURITIES AND EXCHANGE COMMISSION Staff Legal Bulletin No. 4 (CF) ACTION: Publication of CF Staff Legal Bulletin DATE: September 16,

Spin-Offs – Tax Free § IRC 355 Stage 1Stage 2 Parent Firm Parent Firm Shareholders Subsidiary Parent Firm Parent Firm Shareholders Subsidiary Independent of Former Parent Subsidiary Stock Paid to Shareholders As Dividend Or NOT Parent Shareholders Own Both Parent & Subsidiary Stock 10

Examples 2013 and prior Kimberly Clark – November 2013/2014 –KC - $42B – spin off health care business –$2 B sales, $200M profit – 8% sales/7%profit –Tax free § 355 – low teens EV/EBITDA $3-4B –Each KC share – has imbedded $9 HC value Ingersoll Rand and Allegion – 2013/14 Fortune ConocoPhillips Kraft Marathon ITT Corporation 11

Kraft Spin-Off¹ ² Kraft purchased Cadbury $19B Kraft 2 nd largest global food company/$20 CEO Rosenfeld – bigger is better and “scale is a source of great competitive advantage” (2010) 2011 – separate snacks & groceries. “Instill focus that will provide even greater opportunities” ¹ Chon, Das, Ziobro, Activists Pressed for Kraft Spinoff, Wall Street Journal, August 5, planned-spin-off-of-north-american-grocery-company html 12

Kraft Spin-Off (Mondolez/Kraft) Broad based investor support for spinoff A –Europe, develop mkts, NA snacks, conf –$32B – Oreo, Cadbury, Trident & Tang B – NA groceries KRAFT –$16B – Kraft, Maxwell, Oscar Mayer, Jell-O A – Faster growing in emerging markets B – Less growth, strong margins, reliable sales and may pay dividends 13

Kraft Spin-Off Issues: “different portfolios” –Reduce regulatory scrutiny – ConAgra Foods –Delivery – groceries/warehouse; snacks/shelve –Cadbury – originally seen as complementary & benefitting from “global scope, scale, technologies –Within few months – Cadbury split in works. Current Developments¹ –Rosenfeld – Heads up A –Anthony Vernon – Heads up B –SEC filings – Q See prior slide 13, April 2,2012 ¹ Jargon, Ziobro, Kraft Hashes Out Details of Split, Wall Street Journal, December 6,

Kraft Spin-Off Tougher Job ? Vernon –$17B business – ½ revenue and brands –Sales force less leverage –Prices & contract terms less negotiable? –Some products/brands need licensing? Philadelphia Cream Cheese and Gevalia Coffee –Some products change silos – Planters to B Emergence of Planter’s snacks Tax free - IRS ruling May

Kraft Spin-Off Market reaction¹ –Results 1-2 years. Sell now? –More growth oriented and entrepreneurial? –Easier to value entities –Kraft paid $18.5B - $750M synergies 2013 but need to add $1.5B so price tag is really $20B –Value/synergies not happening. Split masks? –“Split produces two so-so businesses” –TEV – 9/7/ X EBITDA = Expensive –Other valuation - $29.50; price $34.08 –12/8/11 - $36.33; Monday – pre deal $39.56, ↓ –12/5/13 – Mondolez - $34; Kraft $ 53 16

GE Security & UTC¹ August 2009 – JP Morgan hired to sell –Revenues - $1.8B, seeking $2B, Price $1.8B UTC Fire & Security $6B revenues, security business shallow. 60% svc/install Access business is strong but GE Casi competes. –Keep both? UTC product is better. –Neither have good video surveillance –UTC – increase service $; weak products Security community does not see the value but a win for industry. 50/50 estimate of success. April UTC² : deeply committed; expanded activities; $150M R&D, new test center, “very optimistic” ¹ ²

Equity Carve-outs Two forms: Initial public offering (IPO) and subsidiary equity carve-out IPOs represent the first offering of stock to the public of all or a portion of the equity of a formerly privately held firm (e.g., UPS sells 9% of its shares in 1999), Groupon 2011 and Dunkin Donuts –The cash may be retained by the parent or returned to shareholders Subsidiary equity carve-out is a transaction in which the parent sells a portion of the stock of a wholly-owned subsidiary to the public. (e.g., Phillip Morris’ 2001 sale of 15% of its Kraft subsidiary) –The cash may be invested in the subsidiary, retained by the parent, or returned to the parent’s shareholders –Although the parent generally sells less than 20% of the sub’s equity, the sub’s shareholder base may be different than that of the parent 18

Equity Carve-Outs Private Firm Sells A Portion of Its Equity to the Public Public/Private Equity Markets Parent Firm Sells A Portion of Its Subsidiary Stock to the Public Public/Private Equity Markets Subsidiary of Parent Firm Initial Public Offering Subsidiary Equity Carve-Out Cash Stock Subsidiary Stock Cash 19

Tracking Stocks – 1980s & early 1990s Separate classes of common stock created by the parent for one or more of its operating units (e.g., USX creates Marathon Oil stock in 1991); Entertainment industry Each class of stock links the shareholder’s return to the performance of the individual operating unit For the investor, such shares enable investment in a single operating unit rather than in the parent For the parent and the operating unit, such shares –Give the parent another means of raising capital, –Represent an “acquisition currency” for the unit, and –Provide an equity-based incentive plan to attract and maintain key managers 20

Tracking Stocks Parent Firm Parent Common Sub 1 Tracking Stock Sub 2 Tracking Stock Sub 3 Tracking Stock Subsidiary 1Subsidiary 2Subsidiary 3 Tracking Stocks Issued by the Parent Firm Value of the Tracking Stock Depends on the Performance of Subsidiary 21

Split-Offs A variation of a spin-off in which some parent company shareholders receive shares in a subsidiary in return for their parent shares. (e.g., AT&T spun-off its wireless operations in 2001 to its shareholders for their AT&T shares) Frequently used when a parent owns a less than 100% investment stake 1 in a subsidiary in order to: –Reduce pressure on the spun-off firm’s share price, because shareholders who exchange their stock are less likely to sell the new stock and –Increase the parent’s EPS by reducing the number of its shares outstanding 1 Potential buyers generally prefer divested units in which they can purchase 100% of stock to avoid minority shareholders. 22

Split-Offs Stage 1 Stage 2 Parent Firm Parent Firm Shareholders Subsidiary Parent Firm Former Parent Firm Shareholders Subsidiary Independent of Former Parent Subsidiary Stock Subsidiary stock now held by former parent shareholders. Parent has no relationship with former subsidiary Parent Stock 23

Voluntary Liquidations or Bust-Ups Involves the sale of all of a firm’s individual operating units After paying off any remaining outstanding liabilities, after-tax proceeds are returned to the parent’s shareholders and the corporate shell is dissolved This option may be pursued if management views the growth prospects of the consolidated firm as limited 24

Going Private - BuyBacks Multiple motivations - examples 2010 survey¹ – 60 large deals worldwide Examples –Burger King –Del Monte –Dynegy –J Crew –JoAnn Stores –Novell –Chrysalis PLC (Europe) –Fuji Foods (Asia) ¹ Weil, Gotshal & Manges Sponsor Backed Going Private Transaction – September

Choosing Appropriate Restructuring Strategy: Viable Firms Choice heavily influenced by the following: –Parent’s need for cash –Degree of operating unit’s synergy with parent –Potential selling price of operating unity Implications: –Parent firms needing cash more likely to divest or engage in equity carve-out for operations exhibiting high selling prices relative to their synergy value –Parent firms not needing cash more likely to spin-off units exhibiting low selling prices and synergy with parent –Parent firms with moderate cash needs likely to engage in equity carve-out when unit’s selling price is low relative to synergy 26

Discussion Questions 1.Divestitures, equity carve-outs, and spin-offs represent alternative restructuring strategies? Explain the primary advantages and disadvantages of each. 2.Under what circumstances might senior management prefer to divest a business unit rather than to spin-off the business? 3.Under what circumstances might senior management prefer an equity carve-out to a spin-off? 27

Things to Remember… Divestitures, spin-offs, equity carve-outs, split- ups, split-offs, and tracking stock are common restructuring strategies to enhance shareholder value Divestitures and equity carve-outs are more likely for operating units whose selling price is much higher than its perceived synergy with parent and whose parents need cash Spin-offs are more likely for operating units whose selling price and synergy are low and whose parent firm does not need cash 28