Where Mergerts Go Wrong

Breaking up is good to do
Restructuring through spin-offs, equity carve-outs, and tracking stocks can create shareholder value.
As large corporations learn to handle the flow of capital and information in a more sophisticated way, they are finding it easier to boost shareholder value by restructuring the capital and assets that make up their businesses. In the past decade, hundreds ofcorporations have used tracking stocks, equity carve-outs, and spin-offs for this purpose.
AT&T´s 1996 ownership restructuring provides a striking example. Before the company announced that it would spin off Lucent Technologies and NCR, its market value was just $75 billion. Little more than a year later, in January 1998, the separately trading AT&T, Lucent, and NCR had a combined marketcapitalization of $159 billion.
We wanted to see whether this level of value creation is the exception or the rule. To that end, we studied the performance of the large ownership restructurings - those in which the parent company had revenues upward of $200 million at the time of disaggregation -that have taken place in the United States during the past decade. We found that such restructurings canindeed increase shareholder value if properly carried out.
Our research looked at three ways of restructuring:
* Tracking stocks, also known as letter or targeted stocks, are a class of parent company stock that tracks the earnings of a division or subsidiary. Typically distributed as a dividend to shareholders in the parent company, these shares can also take the form of an initial publicoffering (IPO).
* Equity carve-outs are an IPO of a stake in a subsidiary. The parent usually keeps majority ownership.
* Spin-offs occur when the entire ownership of a subsidiary is divested as a dividend to shareholders.
In the case of tracking stocks, control remains in the hands of the parent company´s board; in carve-outs and spin-offs, by contrast, management reports to new and separateboards. Similarly, the assets of companies with tracking stocks are not physically separated from those of their corporate parents, though they do have to report earnings separately. In carve-outs and spin-offs, conversely, the subsidiary´s assets are transferred to the new company´s balance sheet.
Carve-outs have assumed a prominent place in US equity activity. In the past ten years, the US stockmarket has seen an average of almost 50 carve-outs a year, or about 10 percent of all IPOs.* One recent example of a substantial carve-out is DuPont´s IPO of Conoco, in October 1998. DuPont raised $4.2 billion for a 30 percent stake in its subsidiary.
The level of spin-off activity has also been high recently: more than 300 spin-offs took place in the United States between January 1988 andSeptember 1998. A notable example of a spin-off was the 1995 breakup of ITT into three businesses - diversified industrial, insurance, and hotels and gaming.
By contrast, tracking stocks are few and far between. Since General Motors issued the first of them with its acquisition of EDS in 1984, a total of 23 have been listed in the United States. Several more have been announced and subsequentlycanceled, and a few others are pending.
Creating value for shareholders
Companies that elect to restructure usually have one goal in mind: creating value for shareholders. Empirical evidence in the form both of price-toearnings (P/E) multiples and total return to shareholders (TRS) – the combined capital appreciation and dividend yield of an equity Ñ demonstrates that, on average, each form ofrestructuring creates value.
Gains in stock prices flow from four changes. First, there is an increase in coverage by analysts. This seems to support investment bankers´ claims that floating equity in business units not previously exposed to the market makes their operating performance more transparent and raises shareholder returns by revealing hidden value. This transparency, however, comes not...