Other Types of Restructuring: Spin-offs, Split-offs, Carve-outs, and Letter Stocks

In many cases, mergers and acquisitions are performed with business units which are carved out of existing companies. In some cases, these are companies which were established as separate units within existing and well-established companies, and which are raising money in the private or public markets to continue their operations. In other cases, shares in business units within a company are distributed to the company's shareholders (spin-off). This section briefly reviews the customary spin-off options, starting from spin-offs of subsidiaries through the raising of capital for subsidiary units and ending in the creation of shares whose performance is linked to the performance of units within the company. These mechanisms are commonly used in situations where the restructured business units could be valued in the spin-offs and split-offs.

The U.S. Internal Revenue Code enables companies to distribute to their shareholders assets or shares in a subsidiary (with tax exemption) by using the spin-off and split-off mechanisms. In recent years, transactions of this type usually preceded investment rounds by the subsidiary.

Under the spin-off mechanism, the company distributes to its shareholders shares in the subsidiary in proportion to their holdings in the stock market at high valuations. Sometimes these situations can yield absurd situations. For example, when 3Com listed its Palm unit, the value of its holdings in the Palm unit exceeded its entire value. In fact, this is a dividend in kind. Under the split-off mechanism, some of the company's shareholders exchange shares in the company with shares in the subsidiary. In most cases, only some of the shareholders perform this act and not necessarily proportionately to their holdings in the company.

For a company to be able to make transactions of the said types, it must meet the following conditions: The company must have conducted business for at least five years, it cannot have been acquired in the course of the five years preceding the transaction, at least 80% of the subsidiary's shares have to be transferred to the company's shareholders, and the company must prove that the act is not motivated mainly by tax considerations, but rather by other economic considerations.

The company distributing the shares does not receive any cash as a result of the distribution and thus reduces its asset base and its ability to generate cash from the distributed assets. In many cases, following careful tax planning, when parts of the company are about to be acquired, the company's remaining assets might be transferred to a new subsidiary whose shares are distributed among the shareholders, and the parent company can conduct the sale or merger deal with a structure that is optimized to these transactions.

Various studies document higher returns on the shares of companies which perform a spin-off, in which the spun-off company is itself listed for trade. It has also been found that companies which undergo the process increase their probability of being involved in M&A activities later on. From the point of view of value enhancement, such a spin-off could be an interim stage before the acquisition of the spun-off company by another company. Furthermore, the spinning company becomes more suited to companies seeking its new activity profile, which is typically more focused.