Companies Can Improve Their Bottom Lines with a Spin-Off

Slimming Down

Companies Can Improve Their Bottom Lines with a Spin-Off

If your company suffers from growing pains or anticipates a hard stretch due to the current economic climate, you may want to consider a spin-off. Spinning off a business or unit can provide a variety of benefits, such as yielding much-needed cash, removing poorer-performing entities from your balance sheet and freeing up management to concentrate on your core business or pursue more profitable initiatives. To effectively grow your company, in fact, you may need to first scale back.

Several Forms

Spin-offs can take many forms and are accomplished in various degrees. A unit may be fully divested of its parent and become an independent, publicly owned entity. Or it may merely become a subsidiary of the original company, gaining owners but still being run by the same management.

Whatever the spin-off form a company adopts, a wholly owned segment of a larger company becomes a fully or partially independent business. Most often, the divested company’s shares are offered in the public marketplace.

Staging the Transaction

Spin-offs involve several stages, the first – and one of the most critical – being the “pre-spin” period. This is when a company prepares a division to be spun off and announces its intentions to the public. During this period, the company will work with the IRS and SEC to ensure the proposed deal meets all tax and regulatory requirements. The company also must gain its board of directors’ final approval.

From here, spin-offs generally are executed in one of two ways:

  1. Pure spin-offs. This is when the parent company distributes 100% of its ownership of a subsidiary operation as a dividend to current shareholders. After the spin-off is complete, there are two separate public companies. Shareholders have the option of selling their holdings in the new entity, if desired.
  2. Partial spin-offs. Here, the parent company sells an interest of less than 20% in the subsidiary in an SEC-registered initial public offering. This method often appeals to companies that need to raise capital but want to maintain ownership of their subsidiary or shine a spotlight on an undervalued division.

Which type of spin-off a company should pursue primarily depends on its long-term goals. A partial spin-off, for instance, may be a better choice for a division that’s not yet ready to stand on its own but that a parent company nevertheless believes the market has undervalued. Spinning off part of the division could enhance its value for an eventual sale or pure spin-off.

Why Do It?

Spin-offs have long been a popular and successful way for companies to improve their bottom lines and streamline strategic plans. As of this writing, General Electric, for example, is in the process of spinning off its 101-year-old, low-growth appliance business, planning either to sell it outright or accept outside investors in a strategic partnership.

Companies spin off divisions for many reasons. A company may need to raise cash for capital-intensive projects. Similarly, a unit’s elimination could improve the parent company’s credit rating and make it a more attractive loan candidate. Some companies even enjoy tax benefits from a spin-off.

Government regulators may require a public company to remove a division if it’s considering a merger with a competitor. For example, the Federal Trade Commission might ask merging companies to divest similar businesses that could, if joined, enjoy too large a market share.

Sometimes spin-offs are accomplished for strategic reasons. A company might spin off a healthy entity with strong growth prospects to gain greater investor attention. Say, for example, that a company has a promising software division that’s undervalued because its parent company isn’t well known in the software sector. If that division is put up for sale and no longer buried in a larger company’s basement, it could receive the market attention it deserves.

Finally, a unit could be a poor performer that has become a drag on the parent company’s earnings. Selling troubled units can be challenging, however. To compensate for additional buyer’s risk, you may need to retain an equity stake in the division or provide financing for the seller.

Benefit of Separation

Whether your company is undercapitalized and looking for cash with which to pursue new markets or make business acquisitions, or you simply believe that a current division could be more competitive as a separate company, consider a spin-off. Separations can be painful, and they require some time and expense. But the benefits can more than make up for the trouble. ______________________________________________________

Ensure Your Spin-Off Isn’t Taxing

One advantage of spinning off a subsidiary is the potential for major tax savings. Although, selling a subsidiary outright typically means that your company will pay substantial capital gains taxes, tax professionals can help you structure the transaction to minimize the burden.

The key is to comply with Internal Revenue Code Section 355, which requires a spin-off company to have existed as a subsidiary for at least five years. It also demands that:

  • The spin-off be undertaken for “a real and substantial non-federal tax purpose” and not just to dodge the IRS;
  • Before the spin-off is conducted, the parent company own at least 80% of the total combined voting power and 80% of each class of nonvoting stock of the subsidiary;
  • Both parent and subsidiary be involved in what the IRS terms an “active” business immediately after the spin-off, and
  • At least one shareholder of the parent company retains a minimum 50% equity interest in the spin-off.

If you spin-off doesn’t conform to Sec. 355, your company could be held liable for the full tax obligation on the divestiture. Meanwhile, your shareholders could be taxed as if they had received a dividend. _______________________________________________________________

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Loose Lips Sink Deals

JoAnn Lombardi VR President  
Confidentiality Agreements are Essential When It Comes to M&As During World War II, posters showed Uncle Sam with a finger to his lips superimposed over a freight ship. The caption read "Loose Lips Sink Ships." It was a clever way to remind troops never to discuss confidential information, lest they unintentionally disclose secrets to the enemy that could cause disaster. Though ramifications of breaching a business deal are not as dire, maintaining strict silence is still critical….

January 29th, 2013 Market Update

Today we are seeing some weakness in Europe and in the US futures markets primarily as due to profit taking.  Overnight in Asia however markets were higher primarily on news that the Indian government had cut the benchmark lending rate to 7.75% from 8.00%. Indices were higher by about a point across the board on further increased liquidity to the region.

Europe is off about a quarter point even with news that Italy’s borrowing costs have fallen to new three year lows at the latest auction yesterday.

In the US futures are down about a quarter point currently.

The Case Shiller Housing Index was released for November and once again year over year the index has advanced, this time by 5.52% vs. estimates of 5.55%.  While the number was slightly under estimates it virtually hit the mark and also rose for the 11th straight month.  The housing recovery in the US continues to plod along and provide positive confidence numbers.

Earnings on mandate positions were released this morning on CP, Pfizer and Metro.  CP came in adjusted at estimates or $1.28 per share.  The company exceeded revenue forecasts and the all important Operating Ration fell to 74.8 from 78.5 (lower is better in the rails).  The company also guided to a very strong second half of 2013 with record revenues and earnings.  Pfizer, came in at $0.47 per share vs. $0.44 estimated.  The company also beat on the top line.  They did however caution on the balance of 2013 with lower guidance.  Metro, the big Canadian food chain had not released earnings as of yet today but did increase its dividend this morning by 16%.  The estimates on earnings are at $1.15 per share.

Both gold and oil are higher this morning rebounding against the profit taking on the Euro and North American markets.

Moody’s yesterday downgraded all of the big Canadian banks except the Royal (which was downgraded in June) citing concerns in the housing sector and the increasing consumer debt load that Canadians continue to pile on.  Canadian consumer debt as a percentage of household income hit the record 165% level in Q3 of last year and while the Q4 numbers have not been released as of yet estimates would suggest it will still be hovering around levels that the US consumer was dealing with back in 2008 just prior to the crisis down there.  I continue to reiterate to all if you can reduce debt do it, regardless of how low interest rates are as they will not stay at these levels for ever.

In Canada, Consumer Confidence was up 5.1% in December which despite the debt concerns shows that Canadians, much like our friends to the south, are continuing to see positive economic signs.

Courtesy of:

Kenneth A. Dick, BA, CIM, CFP, FCSI

Europe Moving In The Right Direction

Today we are seeing some solid upside out of Europe, despite the possibility the UK may slip back into recession for the third time.  Mario Draghi, the ECB head, reiterated again at the World Economic Forum in Davos that he sees the Euro recovery to improve into the second half of the year.  Also driving Euro markets is the positive news out of Germany indicating business morale continues to rise.  Euro markets at midday are up about three quarters of a point.

Moving across the pond, US futures are stronger on the news out of Europe and continued positive earnings results as P&G, Honeywell, Kimberly Clark and Haliburton all beat estimates.  Futures are currently higher by about a quarter point.

Gold is off more the $10.00 this morning while oil continues to decouple and is up again today by about a half a point.

In Canada, a survey of analysts is suggesting the inflation target should get back into the 2% area in December but just which is the level the BOC would like it at.  Also, based on the fact the BOC in its statement earlier in the week suggested that it would not be moving to increase interest rates earlier than previously indicated caused a big slide in the Loonie yesterday which has brought our currency back to par with the USD.

Lastly, yesterday we had the tale of two companies yesterday.  Apple plummeted more than 10% on a revenue miss (earnings beat estimates) and dragged the entire sector down with it including RIM until news came out of China that hardware maker Lenovo suggested there would be some solid M&A opportunities concerning the stock.  The news caused the stock which did fall earlier in the day to finish higher.  With that said, it would seem the likelihood of a Chinese company buying the “Canadian Crown Jewel”,  to quote Steven Harper would be highly unlikely.  Also, I might suggest that the US government would have something to say as they still use the BB and national security could be compromised.  The saga continues…………..

Courtesy of:

Kenneth A. Dick, BA, CIM, CFP

Keys to Negotiating a Successful M&A Deal

Keys to Negotiating a Successful M&A Deal  Whether you’re buying or selling a business, a few guidelines can help you negotiate a deal more effectively and improve your chances for an advantageous outcome. While you’re probably already familiar with basic negotiation strategies, most parties to an M&A transaction can use a refresher course when it comes to what may be the biggest deal of their lives.

Know Yourself

Good negotiators start by knowing themselves. Before you enter into sale negotiations, take time to identify your goals and your tactics for achieving them. If you’re buying, what’s your “reservation price”-the most you’re willing to pay? Would you be able to walk away from the deal if the seller refuses to budge on price?

If you’re selling, similar questions apply:

  • What’s the lowest offer you’ll accept?
  • Are you in a hurry to sell?
  • What conditions will you require as part of the sale?

For example, the retention of certain employees may be a priority. Also be prepared to speak confidently about your business’ strengths and address any perceived weaknesses. Since the buyer’s negotiating leverage emphasizes your weaknesses, you need to be aware of them and ready to provide a solution that mitigates an adverse effect on the buyer’s offering price.

Know the Other Party

Knowing the other side is as important as understanding your own priorities. This knowledge allows you to map out the negotiation ahead of time. As a buyer, you should have a thorough understanding of the business-gained through extensive due diligence.

If you’re a seller, it’s essential to know that your buyer can afford to purchase the business and, if the deal will be seller-financed, how well the company will be run while the note is being paid off. It’s also helpful to learn if your buyer has looked at many other businesses. Buyers who know they have other options if your deal falls through will probably drive a harder bargain.

Gathering knowledge involves more than research; you also need to be a good listener.

If you’re talkative by nature, make an effort to speak less and listen more when meeting with the other party. The better you understand them, the greater chance you have of anticipating their moves and preparing counter offers.

Build a Relationship

There are plenty of opportunities for differences of opinion in any business transaction, and a business sale is no different. Establishing a cordial relationship can go a long way toward reducing misunderstandings or unintended offenses. Social occasions such as dinner or a golf outing can break the ice. Expressing interest in the other party’s opinion and a sense of humor also can help build a good working relationship.

Going back on your word, exaggerating points or misrepresenting facts in an attempt to strengthen your position, on the other hand, can damage goodwill. Finally, don’t try to box the other party into an untenable position-it’s a tactic that’s likely to misfire.

Flexible is Vital

Selling a business is a complicated process, of which price is only one component. When entering the negotiation stage, keep in mind other items that are subject to bargaining:

  • Down payment amount;
  • Interest rate on a seller loan;
  • Collateral;
  • Seller warranties;
  • Earn-out provisions;
  • Non-compete agreements.

Also consider the structure of the deal-whether the company’s stock is being acquired, or just its assets. In general, sellers prefer a stock sale and buyers prefer an asset transaction, which provides better cash flow after the deal.

Good negotiators take advantage of the multifaceted nature of the process by remaining flexible throughout. This may mean compromising on some elements to get the ones that are most important to you, such as those related to financing terms, the closing date, employee retention or seller warranties.

With so many moving parts to consider, flexibility can get you past obstacles. If you’re hung up on a tough issue-say, the price of a particular asset-try putting it aside temporarily, moving to less controversial points such as the price of other assets, and then circling back later.

US Jobless Claims Fall, Gold Down

Today we are seeing some positive moves across the globe with Asia higher overnight by a quarter point and Europe trading up by almost a point on the positive news out of the US.

US Weekly Jobless claims fell 37000 last week to 335000 vs. estimates of 360000.  While the weekly numbers are hard to seasonally adjust, the trend seems to be continuing in the US with employment slowly improving.  On the back of this news we also got the Housing Starts for December which were up 12.1% vs. 3.1% estimated.  The real estate market continues to improve in the US which in turn continues to fuel capital markets.  On this news this morning the US futures are trading higher by about a half a point.

The big US banks continued to come with earnings this morning with both Citi Group and Bank of America reporting.  Citi missed by a large margin in earnings and also missed on revenue.  The stock is trading lower by about 2% in the pre-market.  BOA beat estimates ($0.03 vs. $0.02) but took a big charge in the quarter which reduced profitability.  Revenues were below estimates.

Gold is off sharply this morning down about 1% while oil is moving in the opposite direction up about 1% on the positive economic news.

Courtesy of:

Kenneth A. Dick, BA, CIM, CFP, FCSI