Drilling Down on Breaking Up

Keeping sales, spinoffs, split-offs and unit IPOs straight is a thankless but crucial task.
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Over the past year, stray assets have been lining up along Wall Street for interested investors to peruse. While these orphans can be bargains, investors should be clear about what they're getting into before deciding whether to take such deals home.

This week, the Wall Street rummage sale beefed up, with three large U.S. conglomerates --

Texas Instruments

(TXN) - Get Report

,

Duke Energy

(DUK) - Get Report

and

Tyco

(TYC)

-- either announcing or studying some manner of asset sale or breakup.

Shareholders generally like divestitures: A public company signals to the market it will fine-tune its focus by selling an asset, and the market can expect better returns from core segments. But there are so many different types of asset sales -- outright segment divestitures to strategic buyers or private equity firms, spinoffs, split-offs, carve-outs, partial IPOs and reverse mergers in the public market -- that deciding whether a particular transaction will indeed create value requires a probing eye.

Under the Hood

A CEO announces he will break off an asset with a common tagline: "This sale will help us focus on our core segments and unlock significant value." Shareholders, in return, bump up the company's stock on the basis of the expectation of higher returns in the core asset groups.

But depending on how a company chooses to separate an asset, the meaning for the shareholder can be very different.

"The attractiveness of a divestiture is a function of environmental conditions, as well as a company's specific interest in doing such a deal," said Robert Bruner, dean of the Darden Business School at the University of Virginia. A company can have many different reasons for divesting an asset, he says, and a divestiture doesn't always mean streamlining a business.

An outright sale of an asset to a strategic or private equity buyer can, and usually does, help the parent company post better returns in coming quarters. The purchasing entity often assumes management responsibility of the asset, and the directors in the selling company have more time to focus on their simplified business. The company also receives an immediate infusion of cash, which can be plowed into a business in which management presumably has an advantage.

Other peripheral advantages help the parent company. Employee compensation packages are easier to award. For Wall Street analysts, assigning stock-price targets and future multiples becomes clearer. Under the right circumstances, these benefits bring additional upward movement to the stock.

Who's Who

In outright sales, the identity of the buyer makes a difference. Because companies in a similar business can often extract immediate efficiencies from purchased assets, such "strategic buyers" are often willing to pay more. When such a purchaser isn't readily available, sellers are sometimes tempted to lay off assets to professional acquirers such as private equity groups.

"When time is of the essence, because of a need for cash or to placate a raider or hedge funds, selling to one or a group of private equity funds may be the way out, even if the price is somewhat lower," said Enrique Arzac, professor of finance at Columbia Business School.

Private equity has been on a buying binge of late, as financing has become easier and institutional investors have chased returns.

"The super abundance of private equity money is another way of saying that money is cheap," said Bruner, "Private equity companies and hedge funds need to put their money to work. They are calling on large industrial companies with great intensity, and likely offering very attractive prices."

Split the Difference

The private market isn't the only group getting its hands on orphan assets. Public markets also bask in benefits of large companies chipping away at their noncore segments through tongue-twister transactions.

Of the complex transactions, spinoffs and split-offs seem to be the most popular, and companies such as

Wendy's

(WEN) - Get Report

,

McDonalds

(MCD) - Get Report

and

Viacom

(VIAB) - Get Report

are making good on these deals. Motives for moving an asset into the public's hands vary as much as the technique, however.

Unlike in private sales, the parent company usually retains a large percentage of stock of the split-off company, meaning it still has significant interest in its success. As a result, the oft-stated goal of achieving "clarity" is sometimes more buzzword than reality.

A public transfer of a noncore asset does give the selling company a number of other advantages. In a split-off in which a subsidiary is sold in a public offering, the selling company gets quick access to cash without diluting the stock of the parent. The seller receives cash for a small portion of a noncore entity, while leaving the shares of the core business virtually untouched.

The parent company also can see a bump up in the stock price. Often, companies will divest a noncore asset that is seen as a drag on the company's current multiple or share price. Once the asset is spun off, the parent doesn't have the additional weight on the stock price.

Public markets also offer a large premium to prices offered by private buyers -- up to 20%, in some instances. If a company has intentions of selling an asset later, and if the smaller, noncore asset can stand alone in the public market, it suits the company to put a public price on the asset.

"It makes sense whenever possible to establish the value of the company in the public market before selling or spinning of a piece," said Arzac.

Wild Side

The public issuances go beyond split-offs and spinoffs. Companies tend to get creative during times of frenzy, leading to exotic transactions that bewilder even the most sophisticated investor.

Tuesday's deal between

Alberto-Culver

(ACV) - Get Report

and

Regis

(RGS) - Get Report

was unusual by any standard. The transaction was elaborate enough that shares of both companies didn't open on the

New York Stock Exchange

for several minutes after regular trading began.

After a spin-off, a debt restructuring, an acquisition, a dividend and a transfer of cash, shareholders of Alberto-Culver found themselves to be the majority owner of Regis. Still, how the stock of either company should be valued required spreadsheet calculations that would have daunted a banker. Alberto-Culver, whose major subsidiary was billed in most media reports as the asset being acquired, saw its stock swing from $50.62 to $45.60 during the session, before closing at $46.55, a 3% drop on the day. Regis' shares traded between $39.52 and $43.49 before closing at $42.59, an 8% rise.

While no investor can ever be as knowledgeable as the investment bankers who might have worked for months on any given transaction, investors still need to be able to tell one deal from another.

"The company's focus is the most valuable. We can't say exactly whether the refocusing of a firm matters more than unlocking hidden value. That will be specific to each situation," says Bruner. "What we can say is that not only should the market pay attention to the near-term effect, but also to the signals each company gives about its future plans."