Exam 16: Alternative Exit and Restructuring Strategies

Which of the following is not true of a split-off?

Although the parent often retains control in an equity carve-out, the shareholder base of the subsidiary may be different that that of the parent.

Explain how executing successfully a large-scale divestiture can be highly complex. This is especially true when the divested unit is integrated with the parent's functional departments and with other units operated by the parent. Consider the challenges of interdependencies, regulatory requirements, and customer and employee perceptions.

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. -Would you expect investors to be better off buying Sara Lee stock or investing in a similar set of consumer product businesses in their own personal investment portfolios? Explain your answer.

In addition, stock-based incentive programs to attract and retain key managers can be implemented for each operation with its own tracking stock.

Although the sale value may exceed the equity value of the business, the parent may choose to retain the business for strategic reasons.

USX Bows to Shareholder Pressure to Split Up the Company As one of the first firms to issue tracking stocks in the mid-1980s, USX relented to ongoing shareholder pressure to divide the firm into two pieces. After experiencing a sharp "boom/bust" cycle throughout the 1970s, U.S. Steel had acquired Marathon Oil, a profitable oil and gas company, in 1982 in what was at the time the second largest merger in U.S. history. Marathon had shown steady growth in sales and earnings throughout the 1970s. USX Corp. was formed in 1986 as the holding company for both U.S. Steel and Marathon Oil. In 1991, USX issued its tracking stocks to create "pure plays" in its primary businesses-steel and oil-and to utilize USX's steel losses, which could be used to reduce Marathon's taxable income. Marathon shareholders have long complained that Marathon's stock was selling at a discount to its peers because of its association with USX. The campaign to split Marathon from U.S. Steel began in earnest in early 2000. On April 25, 2001, 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, a return to the original name of the firm formed in 1901. Under the reorganization plan, U.S. Steel and Marathon would retain the same assets and liabilities already associated with each business. However, Marathon will assume $900 million in debt from U.S. Steel, leaving the steelmaker with $1.3 billion of debt. This assumption of debt by Marathon is an attempt to make U.S. Steel, which continued to lose money until 2004, able to stand on its own financially. The investor community expressed mixed reactions, believing that Marathon would be likely to benefit from a possible takeover attempt, whereas U.S. Steel would not fare as well. Despite the initial investor pessimism, investors in both Marathon and U.S. Steel saw their shares appreciate significantly in the years immediately following the breakup.: -In your judgment, did the breakup of USX into Marathon Oil and United States Steel Corporation make sense? Why or why not?

Investors often evaluate a firm’s performance in terms of how well it does as compared to its peers. Activist investors can force an underperforming firm to change its strategy radically. The Kraft decision to split its businesses is yet another example of the recent trend by highly diversified businesses to increase their product focus. _____________________________________________________________________________________________________ Following a successful career as CEO of PepsiCo’s Frito-Lay, Irene Rosenfeld became the CEO of Kraft Foods in 2006. As the world’s second-largest packaged foods manufacturer, behind Nestlé, Kraft had stumbled in its efforts to increase its global reach by growing in emerging markets. Its brands tended to be old, and the firm was having difficulty developing new, trendy products. Rosenfeld was tasked by its board of directors with turning the firm around. She reasoned that it would take a complete overhaul of Kraft, including organization, culture, operations, marketing, branding, and the product portfolio, to transform the firm. In 2010, the firm made what at the time was viewed by top management as its most transformational move by acquiring British confectionery company Cadbury for $19 billion. While the firm became the world’s largest snack company with the completion of the transaction, it was still entrenched in its traditional business, groceries. The company now owned two very different product portfolios. Between January 2010 and mid-2011, Kraft’s earnings steadily improved, powered by stronger sales. Kraft shares rose almost 25%, more than twice the increase in the S&P 500 stock index. However, it continued to trade throughout this period at a lower price-to-earnings multiple than such competitors as Nestlé and Groupe Danone. Some investors were concerned that Kraft was not realizing the promised synergies from the Cadbury deal. Activist investors (Nelson Peltz’s Trian Fund and Bill Ackman’s Pershing Square Capital Management) had discussions with Kraft’s management about splitting the firm. This plan had the support of Warren Buffett, whose conglomerate, Berkshire Hathaway, was Kraft’s largest investor at that time, with a 6% ownership interest. To avert a proxy fight, Kraft’s board and management announced on August 4, 2011, its intention to restructure the firm radically by separating it into two distinct businesses. Coming just 18 months after the Cadbury deal, investors were initially stunned by the announcement but appeared to avidly support the proposal avidly by driving up the firm’s share price by the end of the day. The proposal entailed separating its faster-growing global snack food business from its slower-growing, more United States–centered grocery business. The separation was completed through a tax-free spin-off to Kraft Food shareholders of the grocery business on October 1, 2012. The global snack food business will be named Mondelez International, while the North American grocery business will retain the Kraft name. Management justified the proposed split-up of the firm as a means of increasing focus, providing greater opportunities, and giving investors a choice between the faster-growing snack business and the slower-growing but more predictable grocery operation. Management also argued that the Cadbury acquisition gave the snack business scale to compete against such competitors as Nestlé and PepsiCo. -Speculate as to why Kraft chose not to divest its grocery business and use the proceeds to either reinvest in its faster growing snack business, to buy back its stock, or a combination of the two?

The parent firm generally retains control of the business involved in an equity carve-out.

Anatomy of a Split-Off: Bristol-Myers Squibb Under the Bristol-Myers Squibb exchange offer of Mead Johnson shares for shares of its common stock, announced on November 16, 2009, each BMS shareholder would receive $1.11 for each $1 of BMS stock tendered and accepted in the exchange offer. The exchange was subject to an upper limit of 0.6027 shares of MJ common stock per share of BMS common. On December 4, 2009, BMS amended the offer by increasing the maximum share exchange ratio to 0.6313, indicating it would accept for exchange a maximum of 269,281,601 shares of its stock and that if the exchange offer were oversubscribed, all shares tendered would be subject to proration. The proration formula was be determined by dividing the maximum number of MJ shares BMS was willing to exchange by the number of BMS shares actually tendered. The actual ratio at which shares of Bristol-Myers common stock and shares of Mead Johnson common stock were exchanged was determined by computing a simple three-day average of the shares of the two firms during December 8-10, 2009, subject to the 0.6313 upper limit. On December 16, 2009, Bristol-Myers announced it would exchange up to 170 million share of Mead Johnson common stock (i.e., all that it owned) for outstanding shares of its stock at an exchange ratio of 0.6313 shares of Mead Johnson common stock for each share of Bristol-Myers common stock tendered and accepted in the exchange offer. Assuming that the three-day average of BMS and MJ share prices was $24.30 and $43.75, respectively, BMS shareholders whose tendered shares were accepted in the exchange offer received the higher of $26.97 . Fractional shares were paid in cash. The actual number of BMS shares tendered totaled 500,547,697, resulting in a proration ratio of 53.80% . Each shareholder tendering BMS shares would only have 53.80% of their tendered shares accepted for the exchange. -Why did Bristol-Myers Squibb prorate the number of shares tendered in the exchange offer?

A firm decides to distribute all of the shares it holds in a subsidiary to its shareholders. The distribution would be called a

Divestitures always result in the parent receiving stock or debt from the buyer.