Spinoff Transactions: Creating Value Through Separation
A spinoff transaction occurs when a company divests itself of a subsidiary. It is a type of de-merger. In this transaction, the company distributes shares of the subsidiary to the company’s existing shareholders. There are several reasons a company might separate its businesses. In many cases, a company might believe its businesses may command higher valuations as standalone companies. In other words, greater profits will accrue without management under one umbrella.
The “parent company” is the one that divests itself of a subsidiary, and the “SpinCo” is the subsidiary. When the transaction closes, the SpinCo becomes a standalone company.
These transactions are often high value and generate large transaction fees for the bankers, law firms, and other advisors involved. In 2019, the total volume of completed spinoffs was $179 billion.
Reasons for Spinoffs
Companies often pursue spinoff transaction because there are strategic benefits to separation. The investors, board of directors, and management teams share this belief. For example, it can enable each business to focus on its operational strengths and avoid overextending financial resources.
De-mergers also help companies take advantage of tax-free treatment. Often, when SpinCo shares are, in effect, dividends for parent company shareholders. Spinoffs are typically tax-free to both the parent company and its shareholders.
Structure and Mechanics of Spinoff Transactions
A spinoff transaction, sometimes called a de-merger transaction, involves a complex series of steps. The level of complexity depends on the extent to which the businesses of the parent company and SpinCo integrate before the transaction. If there is tight integration, it will take more effort to transfer assets and liabilities, renegotiate contracts for shared services, and separate employee benefit plans. The level of complexity will also depend on the business goals of the two companies following the separation.
When a spinoff occurs, the parent company’s shareholders receive SpinCo shares but do not surrender any parent company shares. The distribution ratio is the number of shares for distribution for each share of parent company common stock. The target price for SpinCo determines the distribution ratio.
The parent company and SpinCo enter into several agreements to execute the separation. Some typical agreements include a Separation and Distribution Agreement, a Transition Services Agreement, Tax Matters Agreement, and an Employee Matters Agreement.
In addition, since the SpinCo will be a new public company, the Securities and Exchange Commission (SEC) must review certain disclosure documents. A registration statement on Form 10 registers the securities of SpinCo and gives investors business disclosures. The Form 10’s information statement includes detailed disclosures regarding its recent financial statements, performance metrics, management structure, and operational risks. The company disbursed this information to all parent company shareholders online or by mail.
Tax and Securities Law Implications
One key benefit of a spinoff transaction is the tax savings. For U.S. federal income tax purposes, it must qualify as tax-free under Section 355 of the Internal Revenue Code. To qualify, it must serve a real business purpose other than a tax-free way to distribute cash or profits of the parent company.
Because a spinoff transaction is often structured as a dividend, there are major implications under U.S. securities laws. The parent company’s shareholders are not paying for the spun-off shares, so the transaction is not a sale of the subsidiary’s securities. As a result, there is no transfer of securities for value and according to the Securities Act of 1933 (the “Securities Act”), a “sale” has not occurred. This means the spinoff can be executed without being subject to Securities Act registration requirements. On the other hand, if the spinoff is characterized as a “sale” of SpinCo securities, the transaction would have to be registered.
One recent example of a spinoff transaction was the August 2021 spinoff of Victoria’s Secret by L Brands. As the parent company in this transaction, L Brands completed a tax-free spinoff to separate Victoria’s Secret into an independent, publicly listed company. In connection with the deal, L Brands changed its name to Bath & Body Works. The transaction was valued at approximately $5.2 billion. Other recent examples include the spinoff of Kyndryl Holdings by IBM and the spinoff of Douglas Elliman by the Vector Group.