spinoffs (3)–“bad” spinoffs

In the typical case where multi-line company ABC spins off C, the biggest rewards go to holders of C, although there’s no reason to believe, simply from the fact of a spinoff, that the residual AB won’t do well, too.

value, but for whom?

There are some instances, however, in which the apparent intention of ABC is to stuff C full of detritus before spinning it off.  The whole idea is to make the residual AB more attractive, without regard for the fate of C and its owners.  In some cases, C is so weighted down with liabilities that it almost seems designed to fail.   Some do end up in bankruptcy a short time after they become independent.

In this case, the spinoff may create value   …but it is value for AB, not for C.

the Deal Doctor’s litany of bad spinoffs

I wrote a post about spinoffs that deals with the toxic variety about two years ago.  In it I reference a New York Times article which recites a litany of spinoff failures.  By Steven Davidoff Solomon, the “Deal Professor,” who teaches law at Cal Berkeley, the article is well worth reading.

what a bad spinoff looks like

The characteristics of a “bad” spinoff include:

–having weak operating performance and unattractive prospects

–being burdened with potential legal liabilities from, say, the cleanup of toxic chemicals improperly disposed of

–being loaded with excessive debt, sometimes caused by AB allocating too much of the corporate total to the spinoff.  Sometimes it’s worse, though.  As you can read in the NY Times article linked to above, sometimes AB forces C to borrow large amounts of money pre-spinoff and fork over the proceeds to AB.  This is pretty awful.  To my mind, it’s a clear sign not only to steer clear of the spinoff, but the parent as well.

bad, but not a secret–read the deal documents!

The one point I would make about defending ourselves from “bad” spinoffs is that none of the bad pre-separation stuff that is done to a C (and its shareholders) happens in secret.  Everything must be disclosed in the offering documents filed with the SEC.  The facts may not be in bold print, or underlined or in ALL CAPS.  But it’s there for anyone to read.

Don’t expect the warts to be headline material for the deal roadshow, either.  Don’t think the head of C, who (finally) gets to be an independent CEO, will be 100% objective about his (poor) prospects.  He probably figures he can manage himself out of anything–and it may be his only chance at commend, to boot.  So he’s likely to have serious stars in his eyes.

preliminary prospectus and final:  an arcane note

The preliminary prospectus, sometimes called a red herring, is circulated in advance to potential investors.  Technically speaking, it’s not the official information, however.  That’s only in the final prospectus, given to investors right after the offering.  In my experience, although professionals pore over the preliminary, no one reads the final.

I’ve only seen one instance where the final differed from the preliminary in any meaningful way.  It was Occidental Petroleum’s “bad” spinoff of its meatpacking subsidiary, IBP.  IBP was loaded up with $1 billion of debt at the last minute.  The information only appears in the final.  More info at the bottom of my 2011 post on preliminary and final prospectuses.





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