Redstone Gains From Midway Stake

When it comes to his stake in Midway Games ( MWY), Sumner Redstone appears to have made out like a bandit.

Though not many people can trade $245 million worth of stock for $425 million in cash while still essentially maintaining ownership of the stock, that's what Redstone seems to have done.

Better yet for Redstone, the Viacom ( VIA) chairman, the way he structured the deal likely minimized the amount of tax he'll pay on his $180 million windfall.

How'd he swing such a deal? By getting National Amusements, the movie theater operator he controls, to pay off a debt in exchange for arguably inflated shares of Midway.

In December, Redstone handed over 32.9 million Midway shares to National Amusements. In exchange, National Amusements assumed responsibility for a $425 million personal debt Redstone had with Citigroup ( C).

At the time, the deal didn't look particularly good for Redstone, because Midway's stock was at more than $20 a share -- meaning the stake he transacted was worth a nominal $670 million.

But there's some reason to question how much Redstone's stake was really worth. Midway's stock price had risen more than 500% over the previous three years.

The rising share price, however, didn't reflect improving results: Midway has seen sinking sales of late and hasn't posted a full-year profit in five years.

Instead, the gain was largely the result of Redstone's repeated and massive market purchases of the company's stock.

From September 2003 to December 2005, Redstone's stake -- direct and indirect -- jumped from 13.7 million shares, or 29% of the outstanding stock, to 80 million shares, or 89% of the outstanding stock.

Unloading any significant portion of his stake in Midway on the open market, to pay off his debt for example, likely would have submarined the stock. In fact, even though Redstone's nominal stake in Midway hasn't changed since December, and the company's performance hasn't been much worse, the stock has fallen more than 60%.

It's likely no coincidence that Redstone hasn't made any market purchases of the stock in the last six months.

The stock's decline has made Redstone's deal with National Amusements look increasingly savvy, at least from Redstone's personal perspective. On Wednesday, Midway reported in a regulatory filing that National Amusements had completely paid off the $425 million debt it assumed from Redstone.

Meanwhile, the value of the stake Redstone gave to the company -- which, without Redstone's purchases to prop it up, now better reflects its true value -- is worth less than $245 million.

But because he owns two-thirds of National Amusements, Redstone essentially still controls the 32.9 million shares of Midway he transferred.

Not a bad deal if you can get it.

Better yet, Redstone probably saved himself a few million in taxes as a result of the deal. Had National Amusements just given him the $425 million directly to pay the loan, he likely would have had to claim the amount as income and pay a 35% federal income tax on it.

That works out to be about $148 million.

But Redstone was likely able to claim that his transfer of stock to National Amusements was a stock sale. That means he would have been liable for taxes just on the gains on the stock he transferred to National Amusements.

Assuming that he unloaded stock that he held for more than a year, he'd pay no more than 15% on those gains. Even if he claimed a $425 million gain -- which is likely far more than he really did -- his tax liability would be less than $64 million.

In other words, he would have saved at least $84 million in taxes.

Now that's a really sweet deal.

Because of Redstone's stake in National Amusements, a big chunk of the $425 million to pay off the debt arguably came out of his pocket. But not all of it, given that one-third of the company is outside of his direct control.

Meanwhile, Redstone still controls the stock and no longer has to worry about $425 million in personal debt.

At least someone is profiting on Midway's stock.

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