Exam 16: Alternative Exit and Restructuring Strategies

A diversified automotive parts supplier has decided to sell its valve manufacturing business. This sale is referred to as a

Managing highly diverse and complex portfolios of businesses is both time consuming and distracting. This is particularly true when the businesses are in largely related industries.

AT&T (1984 - 2005)-A POSTER CHILD FOR RESTRUCTURING GONE AWRY Between 1984 and 2000, AT&T underwent four major restructuring programs. These included the government-mandated breakup in 1984, the 1996 effort to eliminate customer conflicts, the 1998 plan to become a broadband powerhouse, and the most recent restructuring program announced in 2000 to correct past mistakes. It is difficult to identify another major corporation that has undergone as much sustained trauma as AT&T. Ironically, a former AT&T operating unit acquired its former parent in 2005. The 1984 Restructure: Changed the Organization But Not the Culture The genesis of Ma Bell's problems may have begun with the consent decree signed with the Department of Justice in 1984, which resulted in the spin-off of its local telephone operations to its shareholders. AT&T retained its long-distance and telecommunications equipment manufacturing operations. Although the breadth of the firm's product offering changed dramatically, little else seems to have changed. The firm remained highly bureaucratic, risk averse, and inward looking. However, substantial market share in the lucrative long-distance market continued to generate huge cash flow for the company, thereby enabling the company to be slow to react to the changing competitive dynamics of the marketplace. The 1996 Restructure: Lack of a Coherent Strategy Cash accumulated from the long-distance business was spent on a variety of ill-conceived strategies such as the firm's foray into the personal computer business. After years of unsuccessfully attempting to redefine the company's strategy, AT&T once again resorted to a major restructure of the firm. In 1996, AT&T spun-off Lucent Technologies (its telecommunications equipment business) and NCR (a computer services business) to shareholders to facilitate Lucent equipment sales to former AT&T operations and to eliminate the non-core NCR computer business. However, this had little impact on the AT&T share price. The 1998 Restructure: Vision Exceeds Ability to Execute In its third major restructure since 1984, AT&T CEO Michael Armstrong passionately unveiled in June of 1998 a daring strategy to transform AT&T from a struggling long-distance telephone company into a broadband internet access and local phone services company. To accomplish this end, he outlined his intentions to acquire cable companies MediaOne Group and Telecommunications Inc. for $58 billion and $48 billion, respectively. The plan was to use cable-TV networks to deliver the first fully integrated package of broadband internet access and local phone service via the cable-TV network. AT&T Could Not Handle Its Early Success During the next several years, Armstrong seemed to be up to the task, cutting sales, general, and administrative expense's share of revenue from 28 percent to 20 percent, giving AT&T a cost structure comparable to its competitors. He attempted to change the bureaucratic culture to one able to compete effectively in the deregulated environment of the post-1996 Telecommunications Act by issuing stock options to all employees, tying compensation to performance, and reducing layers of managers. He used AT&T's stock, as well as cash, to buy the cable companies before the decline in AT&T's long-distance business pushed the stock into a free fall. He also transformed AT&T Wireless from a collection of local businesses into a national business. Notwithstanding these achievements, AT&T experienced major missteps. Employee turnover became a big problem, especially among senior managers. Armstrong also bought Telecommunications and MediaOne when valuations for cable-television assets were near their peak. He paid about $106 billion in 2000, when they were worth about $80 billion. His failure to cut enough deals with other cable operators (e.g., Time Warner) to sell AT&T's local phone service meant that AT&T could market its services only in regional markets rather than on a national basis. In addition, AT&T moved large corporate customers to its Concert joint venture with British Telecom, alienating many AT&T salespeople, who subsequently quit. As a result, customer service deteriorated rapidly and major customers defected. Finally, Armstrong seriously underestimated the pace of erosion in AT&T's long-distance revenue base. AT&T May Have Become Overwhelmed by the Rate of Change What happened? Perhaps AT&T fell victim to the same problems many other acquisitive companies have. AT&T is a company capable of exceptional vision but incapable of effective execution. Effective execution involves buying or building assets at a reasonable cost. Its substantial overpayment for its cable acquisitions meant that it would be unable to earn the returns required by investors in what they would consider a reasonable period. Moreover, Armstrong's efforts to shift from the firm's historical business by buying into the cable-TV business through acquisition had saddled the firm with $62 billion in debt. AT&T tried to do too much too quickly. New initiatives such as high-speed internet access and local telephone services over cable-television network were too small to pick up the slack. Much time and energy seems to have gone into planning and acquiring what were viewed as key building blocks to the strategy. However, there appears to have been insufficient focus and realism in terms of the time and resources required to make all the pieces of the strategy fit together. Some parts of the overall strategy were at odds with other parts. For example, AT&T undercut its core long-distance wired telephone business by offers of free long-distance wireless to attract new subscribers. Despite aggressive efforts to change the culture, AT&T continued to suffer from a culture that evolved in the years before 1996 during which the industry was heavily regulated. That atmosphere bred a culture based on consensus building, ponderously slow decision-making, and a low tolerance for risk. Consequently, the AT&T culture was unprepared for the fiercely competitive deregulated environment of the late 1990s (Truitt, 2001). Furthermore, AT&T created individual tracking stocks for AT&T Wireless and for Liberty Media. The intention of the tracking stocks was to link the unit's stock to its individual performance, create a currency for the unit to make acquisitions, and to provide a new means of motivating the unit's management by giving them stock in their own operation. Unlike a spin-off, AT&T's board continued to exert direct control over these units. In an IPO in April 2000, AT&T sold 14 percent of AT&T's Wireless tracking stock to the public to raise funds and to focus investor attention on the true value of the Wireless operations. Investors Lose Patience Although all of these actions created a sense that grandiose change was imminent, investor patience was wearing thin. Profitability foundered. The market share loss in its long-distance business accelerated. Although cash flow remained strong, it was clear that a cash machine so dependent on the deteriorating long-distance telephone business soon could grind to a halt. Investors' loss of faith was manifested in the sharp decline in AT&T stock that occurred in 2000. The 2000 Restructure: Correcting the Mistakes of the Past Pushed by investor impatience and a growing realization that achieving AT&T's vision would be more time and resource consuming than originally believed, Armstrong announced on October 25, 2000 the breakup of the business for the fourth time. The plan involved the creation of four new independent companies including AT&T Wireless, AT&T Consumer, AT&T Broadband, and Liberty Media. By breaking the company into specific segments, AT&T believed that individual units could operate more efficiently and aggressively. AT&T's consumer long-distance business would be able to enter the digital subscriber line (DSL) market. DSL is a broadband technology based on the telephone wires that connect individual homes with the telephone network. AT&T's cable operations could continue to sell their own fast internet connections and compete directly against AT&T's long-distance telephone business. Moreover, the four individual businesses would create "pure-play" investor opportunities. Specifically, AT&T proposed splitting off in early 2001 AT&T Wireless and issuing tracking stocks to the public in late 2001 for AT&T's Consumer operations, including long-distance and Worldnet Internet service, and AT&T's Broadband (cable) operations. The tracking shares would later be converted to regular AT&T common shares as if issued by AT&T Broadband, making it an independent entity. AT&T would retain AT&T Business Services (i.e., AT&T Lab and Telecommunications Network) with the surviving AT&T entity. Investor reaction was swift and negative. Not swayed by the proposal, investors caused the stock to drop 13 percent in a single day. Moreover, it ended 2000 at 17 ½, down 66 percent from the beginning of the year. The More Things Change The More They Stay The Same On July 10, 2001, AT&T Wireless Services became an independent company, in accordance with plans announced during the 2000 restructure program. AT&T Wireless became a separate company when AT&T converted the tracking shares of the mobile-phone business into common stock and split-off the unit from the parent. AT&T encouraged shareholders to exchange their AT&T common shares for Wireless common shares by offering AT&T shareholders 1.176 Wireless shares for each share of AT&T common. The exchange ratio represented a 6.5 percent premium over AT&T's current common share price. AT&T Wireless shares have fallen 44 percent since AT&T first sold the tracking stock in April 2000. On August 10, 2001, AT&T spun off Liberty Media. After extended discussions, AT&T agreed on December 21, 2001 to merge its broadband unit with Comcast to create the largest cable television and high-speed internet service company in the United States. Without the future growth engine offered by Broadband and Wireless, AT&T's remaining long-distance businesses and business services operations had limited growth prospects. After a decade of tumultuous change, AT&T was back where it was at the beginning of the 1990s. At about $15 billion in late 2004, AT&T's market capitalization was about one-sixth of that of such major competitors as Verizon and SBC. SBC Communications (a former local AT&T operating company) acquired AT&T on November 18, 2005 in a $16 billion deal and promptly renamed the combined firms AT&T. -What challenges did AT&T face in trying to split-up the company in 2000? What might you have done differently to overcome these obstacles?

Baxter to Spin Off Heart Care Unit Baxter International Inc. announced in late 1999 its intention to spin off its underperforming cardiovascular business, creating a new company that will specialize in treatments for heart disease. The new company will have 6000 employees worldwide and annual revenue in excess of $1 billion. The unit sells biological heart valves harvested from pigs and cows, catheters and other products used to monitor hearts during surgery, and heart-assist devices for patients awaiting surgery. Baxter conceded that they have been ''optimizing'' the cardiovascular business by not making the necessary investments to grow the business. In contrast, the unit's primary competitors, Guidant, Medtronic, and Boston Scientific, are spending more on research and investing more on start-up companies that are developing new technologies than is Baxter. With the spin-off, the new company will have the financial resources that formerly had been siphoned off by the parent, to create an environment that will more directly encourage the speed and innovation necessary to compete effectively in this industry. The unit's stock will be used to provide additional incentive for key employees and to serve as a means of making future acquisitions of companies necessary to extend the unit's product offering. -Discuss some of the reasons why you believe the unit may prosper more as an independent operation than as part of Baxter?

When a parent creates a tracking stock for a subsidiary, it is giving up all control of that subsidiary.

On April 25, 2001, in an effort to increase shareholder value, USX announced its intention to split U.S. Steel and Marathon Oil into two separately traded companies. The breakup gives holders of Marathon Oil stock an opportunity to participate in the ongoing consolidation within the global oil and gas industry. Holders of USX-U.S. Steel Group common stock (target stock) would become holders of newly formed Pittsburgh-based United States Steel Corporation. What other alternatives could USX have pursued to increase shareholder value? Why do you believe they pursued the breakup strategy rather than some of the alternatives?

Which of the following is true about a voluntary bust-up?

Hughes Corporation's Dramatic Transformation In one of the most dramatic redirections of corporate strategy in U.S. history, Hughes Corporation transformed itself from a defense industry behemoth into the world's largest digital information and communications company. Once California's largest manufacturing employer, Hughes Corporation built spacecraft, the world's first working laser, communications satellites, radar systems, and military weapons systems. However, by the late 1990s, the firm had undergone substantial gut-wrenching change to reposition the firm in what was viewed as a more attractive growth opportunity. This transformation culminated in the firm being acquired in 2004 by News Corp., a global media empire. To accomplish this transformation, Hughes divested its communications satellite businesses and its auto electronics operation. The corporate overhaul created a firm focused on direct-to-home satellite broadcasting with its DirecTV service offering. DirecTV's introduction to nearly 12 million U.S. homes was a technology made possible by U.S. military spending during the early 1980s. Although military spending had fueled much of Hughes' growth during the decade of the 1980s, it was becoming increasingly clear by 1988 that the level of defense spending of the Reagan years was coming to a close with the winding down of the cold war. For the next several years, Hughes attempted to find profitable niches in the rapidly consolidating U.S. defense contracting industry. Hughes acquired General Dynamics' missile business and made 15 smaller defense-related acquisitions. Eventually, Hughes' parent firm, General Motors, lost enthusiasm for additional investment in defense-related businesses. GM decided that, if Hughes could not participate in the shrinking defense industry, there was no reason to retain any interests in the industry at all. In November 1995, Hughes initiated discussions with Raytheon, and two years later, it sold its aerospace and defense business to Raytheon for $9.8 billion. The firm also merged its Delco product line with GM's Delphi automotive systems. What remained was the firm's telecommunications division. Hughes had transformed itself from a $16 billion defense contractor to a svelte $4 billion telecommunications business. Hughes' telecommunications unit was its smallest operation but, with DirecTV, its fastest growing. The transformation was to exact a huge cultural toll on Hughes' employees, most of whom had spent their careers dealing with the U.S. Department of Defense. Hughes moved to hire people aggressively from the cable and broadcast businesses. By the late 1990s, former Hughes' employees constituted only 15-20 percent of DirecTV's total employees. Restructuring continued through the end of the 1990s. In 2000, Hughes sold its satellite manufacturing operations to Boeing for $3.75 billion. This eliminated the last component of the old Hughes and cut its workforce in half. In December 2000, Hughes paid about $180 million for Telocity, a firm that provides digital subscriber line service through phone lines. This acquisition allowed Hughes to provide high-speed Internet connections through its existing satellite service, mainly in more remote rural areas, as well as phone lines targeted at city dwellers. Hughes now could market the same combination of high-speed Internet services and video offered by cable providers, Hughes' primary competitor. In need of cash, GM put Hughes up for sale in late 2000, expressing confidence that there would be a flood of lucrative offers. However, the faltering economy and stock market resulted in GM receiving only one serious bid, from media tycoon Rupert Murdoch of News Corp. in February 2001. But, internal discord within Hughes and GM over the possible buyer of Hughes Electronics caused GM to backpedal and seek alternative bidders. In late October 2001, GM agreed to sell its Hughes Electronics subsidiary and its DirecTV home satellite network to EchoStar Communication for $25.8 billion. However, regulators concerned about the antitrust implications of the deal disallowed this transaction. In early 2004, News Corp., General Motors, and Hughes reached a definitive agreement in which News Corp acquired GM's 19.9 percent stake in Hughes and an additional 14.1 percent of Hughes from public shareholders and GM's pension and other benefit plans. News Corp. paid about $14 per share, making the deal worth about $6.6 billion for 34.1 percent of Hughes. The implied value of 100 percent of Hughes was, at that time, $19.4 billion, about three fourths of EchoStar's valuation three years earlier. -What risks did Hughes face in moving completely away from its core defense business and into a high-technology commercial business? In your judgment, did Hughes move too quickly or too slowly? Explain your answer.

Gillette Announces Divestiture Plans With 1998 sales of $10.1 billion, Gillette is the world leader in the production of razor blades, razors, and shaving cream. Gillette also has a leading position in the production of pens and other writing instruments. Gillette's consolidated operating performance during 1999 depended on its core razor blade and razor, Duracell battery, and oral care businesses. Reflecting disappointment in the performance of certain operating units, Gillette's CEO, Michael Hawley, announced in October 1999 his intention to divest poorly performing businesses unless he could be convinced by early 2000 that they could be turned around. The businesses under consideration at that time comprised about 15% of the company's $10 billion in annual sales. Hawley saw the new focus of the company to be in razor blades, batteries, and oral care. To achieve this new focus, Hawley intended to prune the firm's product portfolio. The most likely targets for divestiture at the time included pens (i.e., PaperMate, Parker, and Waterman), with the prospects for operating performance for these units considered dismal. Other units under consideration for divestiture included Braun and toiletries. With respect to these businesses, Hawley apparently intended to be selective. At Braun, where overall operating profits plunged 43% in the first three quarters of 1999, Hawley has announced that Gillette will keep electric shavers and electric toothbrushes. However, the household and personal care appliance units are likely divestiture candidates. The timing of these sales may be poor. A decision to sell Braun at this time would compete against Black & Decker's recently announced decision to sell its appliance business. Although Gillette would be smaller, the firm believes that its margins will improve and that its earnings growth will be more rapid. Moreover, divesting such problem businesses as pens and appliances would let management focus on the units whose prospects are the brightest. These are businesses that Gillette's previous management was simply not willing to sell because of their perceived high potential. -Describe the process Gillette's management may have gone through to determine which business units to sell and which to keep.

Empirical studies show that exit strategies, which return cash to shareholders, tend to have a highly unfavorable impact on shareholder wealth creation.

Parent firms with a high tax basis in a business may choose to spin-off the unit as a tax-free distribution to shareholders rather than sell the business and incur a substantial tax liability.

Split-ups and spin-offs generally are taxable to shareholders.

Step 1: Kraft creates a shell subsidiary (Kraft Sub) and transfers Post assets and liabilities and $300 million in Kraft debt into the shell in exchange for Kraft Sub stock plus $660 million in Kraft Sub debt securities. Kraft also implements an exchange offer of Kraft Sub for Kraft common stock. Step 2: Kraft Sub, as an independent company, is merged in a forward triangular tax-free merger with a sub of Ralcorp (Ralcorp Sub) in which Kraft Sub shares are exchanged for Ralcorp shares, with Ralcorp Sub surviving. Sara Lee Attempts to Create Value through Restructuring After spurning a series of takeover offers, Sara Lee, a global consumer goods company, announced in early 2011 its intention to split the firm into two separate publicly traded companies. The two companies would consist of the firm’s North American retail and food service division and its international beverage business. The announcement comes after a long string of restructuring efforts designed to increase shareholder value. It remains to be seen if the latest effort will be any more successful than earlier efforts. Reflecting a flawed business strategy, Sara Lee had struggled for more than a decade to create value for its shareholders by radically restructuring its portfolio of businesses. The firm’s business strategy had evolved from one designed in the mid-1980s to market a broad array of consumer products from baked goods to coffee to underwear under the highly recognizable brand name of Sara Lee into one that was designed to refocus the firm on the faster-growing food and beverage and apparel businesses. Despite acquiring several European manufacturers of processed meats in the early 1990s, the company’s profits and share price continued to flounder. In September 1997, Sara Lee embarked on a major restructuring effort designed to boost both profits, which had been growing by about 6% during the previous five years, and the company’s lagging share price. The restructuring program was intended to reduce the firm’s degree of vertical integration, shifting from a manufacturing and sales orientation to one focused on marketing the firm’s top brands. The firm increasingly viewed itself as more of a marketing than a manufacturing enterprise. Sara Lee outsourced or sold 110 manufacturing and distribution facilities over the next two years. Nearly 10,000 employees, representing 7% of the workforce, were laid off. The proceeds from the sale of facilities and the cost savings from outsourcing were either reinvested in the firm’s core food businesses or used to repurchase $3 billion in company stock. 1n 1999 and 2000, the firm acquired several brands in an effort to bolster its core coffee operations, including such names as Chock Full o’Nuts, Hills Bros, and Chase & Sanborn. Despite these restructuring efforts, the firm’s stock price continued to drift lower. In an attempt to reverse the firm’s misfortunes, the firm announced an even more ambitious restructuring plan in 2000. Sara Lee would focus on three main areas: food and beverages, underwear, and household products. The restructuring efforts resulted in the shutdown of a number of meat packing plants and a number of small divestitures, resulting in a 10% reduction (about 13,000 people) in the firm’s workforce. Sara Lee also completed the largest acquisition in its history, purchasing The Earthgrains Company for $1.9 billion plus the assumption of $0.9 billion in debt. With annual revenue of $2.6 billion, Earthgrains specialized in fresh packaged bread and refrigerated dough. However, despite ongoing restructuring activities, Sara Lee continued to underperform the broader stock market indices. In February 2005, Sara Lee executed its most ambitious plan to transform the firm into a company focused on the global food, beverage, and household and body care businesses. To this end, the firm announced plans to dispose of 40% of its revenues, totaling more than $8 billion, including its apparel, European packaged meats, U.S. retail coffee, and direct sales businesses. In 2006, the firm announced that it had completed the sale of its branded apparel business in Europe, Global Body Care and European Detergents units, and its European meat processing operations. Furthermore, the firm spun off its U.S. Branded Apparel unit into a separate publicly traded firm called HanesBrands Inc. The firm raised more than $3.7 billion in cash from the divestitures. The firm was now focused on its core businesses: food, beverages, and household and body care. In late 2008, Sara Lee announced that it would close its kosher meat processing business and sold its retail coffee business. In 2009, the firm sold its Household and Body Care business to Unilever for $1.6 billion and its hair care business to Procter & Gamble for $0.4 billion. In 2010, the proceeds of the divestitures made the prior year were used to repurchase $1.3 billion of Sara Lee’s outstanding shares. The firm also announced its intention to repurchase another $3 billion of its shares during the next three years. If completed, this would amount to about one-third of its approximate $10 billion market capitalization at the end of 2010. What remains of the firm are food brands in North America, including Hillshire Farm, Ball Park, and Jimmy Dean processed meats and Sara Lee baked goods and Earthgrains. A food distribution unit will also remain in North America, as will its beverage and bakery operations. Sara Lee is rapidly moving to become a food, beverage, and bakery firm. As it becomes more focused, it could become a takeover target. Has the 2005 restructuring program worked? To answer this question, it is necessary to determine the percentage change in Sara Lee’s share price from the announcement date of the restructuring program to the end of 2010, as well as the percentage change in the share price of HanesBrands Inc., which was spun off on August 18, 2006. Sara Lee shareholders of record received one share of HanesBrands Inc. for every eight Sara Lee shares they held. Sara Lee’s share price jumped by 6% on the February 21, 2004 announcement date, closing at $19.56. Six years later, the stock price ended 2010 at $14.90, an approximate 24% decline since the announcement of the restructuring program in early 2005. Immediately following the spinoff, HanesBrands’ stock traded at $22.06 per share; at the end of 2010, the stock traded at $25.99, a 17.8% increase. A shareholder owning 100 Sara Lee shares when the spin-off was announced would have been entitled to 12.5 HanesBrands shares. However, they would have actually received 12 shares plus $11.03 for fractional shares (i.e., 0.5 × $22.06). A shareholder of record who had 100 Sara Lee shares on the announcement date of the restructuring program and held their shares until the end of 2010 would have seen their investment decline 24% from $1,956 (100 shares × $19.56 per share) to $1,486.56 by the end of 2010. However, this would have been partially offset by the appreciation of the HanesBrands shares between 2006 and 2010. Therefore, the total value of the hypothetical shareholder’s investment would have decreased by 7.5% from $1,956 to $1,809.47 (i.e., $1,486.56 + 12 HanesBrands shares × $25.99 + $11.03). This compares to a more modest 5% loss for investors who put the same $1,956 into a Standard & Poor’s 500 stock index fund during the same period. Why did Sara Lee underperform the broader stock market indices during this period? Despite the cumulative buyback of more than $4 billion of its outstanding stock, Sara Lee’s fully diluted earnings per share dropped from $0.90 per share in 2005 to $0.52 per share in 2009. Furthermore, the book value per share, a proxy for the breakup or liquidation value of the firm, dropped from $3.28 in 2005 to $2.93 in 2009, reflecting the ongoing divestiture program. While the HanesBrands spin-off did create value for the shareholder, the amount was far too modest to offset the decline in Sara Lee’s market value. During the same period, total revenue grew at a tepid average annual rate of about 3% to about $13 billion in 2009. -Speculate as to why the 2005 restructure program appears to have been unsuccessful in achieving a sustained increase in Sara Lee's earnings per share and in turn creating value for the Sara Lee shareholders?

In either a public or private solicitation, interested parties are asked to sign confidentiality agreements after they are given access to proprietary information but before they are asked to make a bid.

The timing of a divestiture is important. If the business to be sold is highly cyclical, the sale should be timed to coincide with the firm's peak year earnings.

Divestitures, spin-offs, equity carve-outs, split-ups, and bust-ups are commonly used strategies to exit businesses.

Which of the following is not true of a divestiture?

The Warner Music Group is Sold at Auction In selling a business, a firm may choose either to negotiate with a single potential buyer, to control the number of potential bidders, or to engage in a public auction. The auction process often is viewed as the most effective way to get the highest price for a business to be sold; however, far from simple, an auction can be both a chaotic and a time-consuming procedure. Auctions may be most suitable for businesses whose value is largely intangible or for “hard-to-value” businesses. ____________________________________________________________________________________________________ In early 2011, the Warner Music Group (WMG), the third largest of the “big four” recorded-music companies, consisted of two separate businesses: one showing high growth potential and the other with declining revenues. Of WMG’s $3 billion in annual revenue, 82% came from sales of recorded music, with the remainder attributed to royalty payments for the use of music owned by the firm. Of the two, only recorded music has suffered revenue declines, due to piracy, aggressive pricing of online music sales, and the bankruptcy of many record retailers and wholesalers. In contrast, music publishing has grown as a result of diverse revenue streams from radio, television, advertising, and other sources. Music publishing also is benefiting from digital music downloads and the proliferation of cellphone ringtones. In 2004, Warner Music’s parent at the time, Time Warner Inc., agreed to sell the business to a consortium led by THL Partners for $2.6 billion in cash. The group also included Edward Bronfman, Jr. (the Seagram’s heir, who also became the CEO of WMG), Bain Capital, and Providence Equity Partners. Having held the firm for seven years, a long time for private equity investors, its primary investors were seeking a way to cash out of the business, whose long-term fortunes appeared problematic. WMG’s investors were also in a race with Terra Firma Capital Partners, owner of the venerable British record company EMI, which was expected to take EMI public or to sell the business to a strategic buyer. WMG’s investors were concerned that, if EMI were to be sold before WMG, the firm’s exit strategy would be compromised, because there was much speculation that the only logical buyer for WMG was EMI. By the end of January 2011, WMG had solicited about 70 potential bidders and attracted unsolicited indications of interest from at least 20 others. As this group winnowed through the auction’s three rounds, alliances among the bidders continually changed. In the ensuing auction, WMG’s stock price jumped by 75% from $4.72 per share on January 20 to $8.25 per share, for a total market value of $3.3 billion on May 6, 2011. In view of the differences between these two businesses, WMG was open to selling the firm in total or in pieces, contributing to the extensive bidder interest. Risk takers were betting on an eventual recovery in recorded-music sales, while risk-averse investors were more likely to focus on music publishing. Prior to the auction, WMG distributed confidentiality agreements to 37 suitors, with 10 actually submitting a preliminary bid by the deadline of February 22, 2011. Of the preliminary bids, four were for the entire company, three for recorded music, and three for music publishing. For the entire firm, prices ranged from a low bid of $6 per share to a high bid of $8.25 per share. For recorded music, bids ranged from a low of $700 million to a high of $1.1 billion. Music publishing bids were almost twice that of recorded music, ranging from a low of $1.45 billion to a high of $2 billion. For bidders, the objective is to make it to the next round in the auction; for sellers, the objective is less about prices offered during the initial round and more about determining who is committed to the process and who has the financial wherewithal to consummate the deal. According to the firm’s proxy pertaining to the sale, released on May 20, 2011, the subsequent bidding was characterized as a series of ever-changing alliances among bidders, with Access Industries submitting the winning bid. The sale appears to have been a success from the investors’ standpoint, with some speculating that THL alone earned an internal rate of return (including dividends) of 34%. Motorola Bows to Activist Pressure Under pressure from activist investor Carl Icahn, Motorola felt compelled to make a dramatic move before its May 2008 shareholders' meeting. Icahn had submitted a slate of four directors to replace those up for reelection and demanded that the wireless handset and network manufacturer take actions to improve profitability. Shares of Motorola, which had a market value of $22 billion, had fallen more than 60% since October 2006, making the firm’s board vulnerable in the proxy contest over director reelections. Signaling its willingness to take dramatic action, Motorola announced on March 26, 2008, its intention to create two independent, publicly traded companies. The two new companies would consist of the firm's former Mobile Devices operation (including its Home Devices businesses consisting of modems and set-top boxes) and its Enterprise Mobility Solutions & Wireless Networks business. In addition to the planned spin-off, Motorola agreed to nominate two people supported by Carl Icahn to the firm’s board. Originally scheduled for 2009, the breakup was postponed due to the upheaval in the financial markets that year. The breakup would result in a tax-free distribution to Motorola's shareholders, with shareholders receiving shares of the two independent and publicly traded firms. The Mobile Devices business designs, manufactures, and sells mobile handsets globally, and it has lost more than $5 billion during the last three years. The Enterprise Mobility Solutions & Wireless Networks business manufactures, designs, and services public safety radios, handheld scanners and telecommunications network gear for businesses and government agencies and generates nearly all of the Motorola’s current cash flow. This business also makes network equipment for wireless carriers such as Spring Nextel and Verizon Wireless. By dividing the company in this manner, Motorola would separate its loss-generating Mobility Devices division from its other businesses. Although the third largest handset manufacturer globally, the handset business had been losing market share to Nokia and Samsung Electronics for years. Following the breakup, the Mobility Devices unit would be renamed Motorola Mobility, and the Enterprise Mobility Solutions & Networks operation would be called Motorola Solutions. Motorola’s board is seeking to ensure the financial viability of Motorola Mobility by eliminating its outstanding debt and through a cash infusion. To do so, Motorola intends to buy back nearly all of its outstanding $3.9 billion debt and to transfer as much as $4 billion in cash to Motorola Mobility. Furthermore, Motorola Solutions would assume responsibility for the pension obligations of Motorola Mobility. If Motorola Mobility were to be forced into bankruptcy shortly after the breakup, Motorola Solutions may be held legally responsible for some of the business’s liabilities. The court would have to prove that Motorola had conveyed the Mobility Devices unit (renamed Motorola Mobility following the breakup) to its shareholders, fraudulently knowing that the unit’s financial viability was problematic. Once free of debt and other obligations and flush with cash, Motorola Mobility would be in a better position to make acquisitions and to develop new phones. It would also be more attractive as a takeover target. A stand-alone firm is unencumbered by intercompany relationships, including such things as administrative support or parts and services supplied by other areas of Motorola. Moreover, all liabilities and assets associated with the handset business already would have been identified, making it easier for a potential partner to value the business. In mid-2010, Motorola Inc. announced that it had reached an agreement with Nokia Siemens Networks, a Finnish-German joint venture, to buy the wireless networks operations, formerly part of its Enterprise Mobility Solutions & Wireless Network Devices business for $1.2 billion. On January 4, 2011, Motorola Inc. spun off the common shares of Motorola Mobility it held as a tax-free dividend to its shareholders and renamed the firm Motorola Solutions. Each shareholder of record as of December 21, 2010, would receive one share of Motorola Mobility common for every eight shares of Motorola Inc. common stock they held. Table 15.3 shows the timeline of Motorola’s restructuring effort. Discussion Questions 1. In your judgment, did the breakup of Motorola make sense? Explain your answer. 2. What other restructuring alternatives could Motorola have pursued to increase shareholder value? Why do you believe it pursued this breakup strategy rather than some other option? $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\text {Table 15.3}$ $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\text {Motorola Restructure Timeline}$ Motorola (Beginning 2010) Motorola (Mid-2010) Motorola (Beginning 2011) Mobility Devices Mobility Devices Motorola Mobility spin-off Enterprise Mobility Solutions \& Wireless Networks Enterprise Mobility Solutions* Motorola Inc. renamed Motorola Solutions $\text {*Wireless Networks sold to Nokia-Siemens. }$ Kraft Foods Undertakes Split-Off of Post Cereals in Merger-Related Transaction In August 2008, Kraft Foods announced an exchange offer related to the split-off of its Post Cereals unit and the closing of the merger of its Post Cereals business into a wholly-owned subsidiary of Ralcorp Holdings. Kraft is a major manufacturer and distributor of foods and beverages; Post is a leading manufacturer of breakfast cereals; and Ralcorp manufactures and distributes brand-name products in grocery and mass merchandise food outlets. The objective of the transaction was to allow Kraft shareholders participating in the exchange offer for Kraft Sub stock to become shareholders in Ralcorp and Kraft to receive almost $1 billion in cash or cash equivalents on a tax-free basis. Prior to the transaction, Kraft borrowed $300 million from outside lenders and established Kraft Sub, a shell corporation wholly owned by Kraft. Kraft subsequently transferred the Post assets and associated liabilities, along with the liability Kraft incurred in raising $300 million, to Kraft Sub in exchange for all of Kraft Sub’s stock and $660 million in debt securities issued by Kraft Sub to be paid to Kraft at the end of ten years. In effect, Post was conveyed to Kraft Sub in exchange for assuming Kraft’s $300 million liability, 100% of Kraft Sub’s stock, and Kraft Sub debt securities with a principal amount of $660 million. The consideration that Kraft received, consisting of the debt assumption by Kraft Sub, the debt securities from Kraft Sub, and the Kraft Sub stock, is considered tax free to Kraft, since it is viewed simply as an internal reorganization rather than a sale. Kraft later converted to cash the securities received from Kraft Sub by selling them to a consortium of banks. In the related split-off transaction, Kraft shareholders had the option to exchange their shares of Kraft common stock for shares of Kraft Sub, which owned the assets and liabilities of Post. If Kraft was unable to exchange all of the Kraft Sub common shares, Kraft would distribute the remaining shares as a dividend (i.e., spin-off) on a pro rata basis to Kraft shareholders. With the completion of the merger of Kraft Sub with Ralcorp Sub (a Ralcorp wholly-owned subsidiary), the common shares of Kraft Sub were exchanged for shares of Ralcorp stock on a one for one basis. Consequently, Kraft shareholders tendering their Kraft shares in the exchange offer owned 0.6606 of a share of Ralcorp stock for each Kraft share exchanged as part of the split-off. Concurrent with the exchange offer, Kraft closed the merger of Post with Ralcorp. Kraft shareholders received Ralcorp stock valued at $1.6 billion, resulting in their owning 54% of the merged firm. By satisfying the Morris Trust tax code regulations, the transaction was tax free to Kraft shareholders. Ralcorp Sub was later merged into Ralcorp. As such, Ralcorp assumed the liabilities of Ralcorp Sub, including the $660 million owed to Kraft. The purchase price for Post equaled $2.56 billion. This price consisted of $1.6 billion in Ralcorp stock received by Kraft shareholders and $960 million in cash equivalents received by Kraft. The $960 million included the assumption of the $300 million liability by Kraft Sub and the $660 million in debt securities received from Kraft Sub. The steps involved in the transaction are described -While Kraft's share value did increase following the Cadbury deal, it lagged the performance of key competitors. Why do you believe this was the case? Explain your answer.

Baxter to Spin Off Heart Care Unit Baxter International Inc. announced in late 1999 its intention to spin off its underperforming cardiovascular business, creating a new company that will specialize in treatments for heart disease. The new company will have 6000 employees worldwide and annual revenue in excess of $1 billion. The unit sells biological heart valves harvested from pigs and cows, catheters and other products used to monitor hearts during surgery, and heart-assist devices for patients awaiting surgery. Baxter conceded that they have been ''optimizing'' the cardiovascular business by not making the necessary investments to grow the business. In contrast, the unit's primary competitors, Guidant, Medtronic, and Boston Scientific, are spending more on research and investing more on start-up companies that are developing new technologies than is Baxter. With the spin-off, the new company will have the financial resources that formerly had been siphoned off by the parent, to create an environment that will more directly encourage the speed and innovation necessary to compete effectively in this industry. The unit's stock will be used to provide additional incentive for key employees and to serve as a means of making future acquisitions of companies necessary to extend the unit's product offering. -In your judgment, what did Baxter's management mean when they admitted that they had not been "optimizing" the cardiovascular business in recent years? Explain both the strategic and financial implications of this strategy.

Tracking stocks may create internal operating conflicts among the parent's business units in terms of how the consolidated firm's cash is allocated among its business units.