Breaking Up is Good To Do

The ABCs of Spin-Offs

Spin-Off Research Joe Cornell, CFA

Why Spin-Off?
Spin-Offs are a source of significant market outperformance for investors Spin-Offs often result in a higher aggregate value for the constituent pieces Studies conducted by a range of researchers, from Penn State to McKinsey have documented that spin-offs, on average, outperform market indexes

Spin-Offs Outperform S&P 500

Bloomberg Spin-Off Index up 9.1% Year-To-Date Versus 2.6% for S&P as of June 4, 2012
Ticker BNSPIN^ SPX^ ACCO AMCX AOL BWC CFN FAF FBHS HHC HII MJN MMI MPC MSG PSX QEP TRIP WPX XLS XYL Name Bberg US Spin-Off Index S&P 500 INDEX ACCO BRANDS CORP AMC NETWORKS INC-A AOL INC BABCOCK & WILCOX CO/THE CAREFUSION CORP FIRST AMERICAN FINANCIAL FORTUNE BRANDS HOME & SECURI HOWARD HUGHES CORP/THE HUNTINGTON INGALLS INDUSTRIE MEAD JOHNSON NUTRITION CO MOTOROLA MOBILITY HOLDINGS I MARATHON PETROLEUM CORP MADISON SQUARE GARDEN CO-A PHILLIPS 66 QEP RESOURCES INC TRIPADVISOR INC WPX ENERGY INC EXELIS INC XYLEM INC YTD Current Price 280.9 1278.04 Index Member@ 8.57 37.08 27.11 23.9 24.01 15.7 21.13 57.9 36.5 78.15 39.98 35.24 36.25 29.92 25.3241.02 14.1 9.75 24.48 Total Returns(%)* 1-Year Life Mrk Cap ($Bln) 9.1 -4.3 212.1 90.42 2.6 -0.6 na 11830 -11.2 -1.3 79.5 -1 -5.5 24.5 24.1 31.1 16.7 14.1 N/A 7.2 26.6 N/A -13.5 62.7 -22.4 9.7 -4 7 n/a 31.9 13.6 14.6 3.5 n/a 20.8 1.1 18.5 N/A N/A 36.2 N/A 39.7 N/A N/A N/A N/A 5.5 -7 15.3 3.2 20.7 12.2 71.8 56.9 -12 96 20.7 -14.4 107.1 -8.7 -13.2 48.2 -22.1 -14.3 -6.9 0.97 2.66 2.54 2.83 5.33 1.67 3.37 2.2 1.81 15.93 12.14 12.01 2.74 18.71 4.52 5.51 2.8 1.82 4.54

Types Of Spin-Offs
Type of Spin-Off Description Parent firm distributes shares of the spun-off subsidiary to parent shareholders Sell a portion or all shares of subsidiary through an IPO in the equity market Example
Cadbury

Spin-Off

Schweppes / Dr. Pepper Time Warner / AOL

Carve-Out

Bristol-Myers

/ Mead Johnson Nutrition Citigroup / Primerica

Split-Off

Parent companys shareholders are offered shares of a subsidiary in exchange for the parents shares (exchange offer)

Bristol-Myers

/ Mead Johnson Nutrition Sara Lee / Coach

Spin-Off
A parent distributes the stock of a subsidiary in the form of a dividend Following the distribution, the stockholders hold stock of the parent and the stock of the company that was spun off Two independent companies exist where before there was only one A spin-off effectively removes the parent from management and control of the subsidiary Pure spins are tax efficient

Carve-Out
Parent company sells some or all of the stock of a subsidiary to the public in an IPO The carve-out may pay a portion of the IPO proceeds to its parent Parent companies sometimes link subsidiary IPOs and Spin-Offs (two step spin) Parent would typically sell less than 20% Of subsidiary to the public and then distribute the balance of the stock to their shareholders in a tax-free distribution (Example: Bristol-Myers Squibb / Mead Johnson Nutrition)

Equity Carve-Outs
Parent sells Equity in the New Firm to the Public (IPO) and creates a New Publicly Traded Entity.
Subsidiary 25%

Subsidiary 35% Parent 65%

Carve-Out in an IPO 10%

Parent 65%

A carve-out brings cash into the firm, whereas a pure spin-off does not. Carve-outs disperse assets and ownership in the assets to non-owners of the original firm. Carve-outs are often an intermediate step before a full spin-off.

Split-Offs
In a split-off, the investor must decide between the new company and the parent. Holders of the parent company stock must choose to continue owning stock in the parent or, instead, exchange some or all of the parent stock for stock in the spin-off. The parent offers its existing shareholders stock in the subsidiary in exchange for shares in the parent company. If the parent distributes 80% of the subsidiary stock, the split is tax-free. Whats more, in an effort to induce enough shareholders to swap stock, investors are offered shares in the subsidiary that are worth more than the shares being returned to the parent company. This offered premium explains why split-offs are often oversubscribed.

Selected Split-Off Transactions

% of Parent Shares Size Repurcha Initial Closing ($mm) sed Prem. Prem.
$7.8 B $998 M $8.27 B $11.7 B $906 M $1.55 B 10% 5% 14% 13% 4% 6% 7% 12.90% 17.70% 17.90% 17.50% 13.10% 1% 6.90% 10.10% 3.30% 5.20% 8.80%

Parent/Sub
AT&T / AWE Sara Lee / Coach General Motors / Hughes Electronics DuPont / Conoco Lockheed Martin / Martin Marietta Eli Lilly / Guidant

Date
5/21/01 4/4/01 5/19/00 8/6/99 10/18/96 9/18/95

Over Sub. Factor

.87x 2.1x 3.9x 2.4x 5.4x 2.9x

Sub as % of Parent Market

22% 6% 70% 20% 6% 9%

Drivers for Spin-Offs

Lack of synergy De-conglomeration Focus in core business Legal / regulatory Undervalued assets Monetize value of subsidiary De-leverage balance sheet Riskiness of the subsidiary Avoid a takeover Tax avoidance Conflicts of interest

Successful Spins
Easier for the markets to recognize underlying value Pursue compelling business opportunities Greater freedom to pursue new ventures, streamline production, and pare overhead Accountability and direct incentives (stock & options) Eliminates competitive disadvantages Greater access to capital Increase corporate focus for the spin-off and parent

Shift from Conglomeration to Pure Play

Era of conglomerate (1960s - 1980s) - Firms diversify holdings to smooth earnings - Market rewards empire building Conglomerates fall out of favor - Focus on cost - Difficult to value all businesses in diversified companies - Market discounts conglomerate stocks Rise of the Pure Play (1990s - Current) - Market rewards firms that concentrate on core business - Competitive landscape pressures management to improve operating efficiency and clarify strategic decision making

Number of Completed U.S. Spin-Offs by Year

70
66 66

60

50
44 41 39 36 33 27 21 18 27 23 28 21 31 27 41 35 31 34 29 27 20 20

40
34

30
19

27

20

10

1993

1995

1985

1986

1987

1988

1989

1990

1991

1992

1994

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011