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Research on the Profitability of Carve-outs, Spin-offs, Split-offs, and Tracking Stock

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The general finding is that carve-outs, spin-offs, and tracking stock are neutral to beneficial for shareholders. Exhibits 6.17 and 6.18 summarize studies of the event returns associated with spin-offs and carve-outs; these are generally profitable to investors. Exhibit 6.19 on page 164 shows that tracking stock is value neutral to slightly positive for investors.

Research amplifies some of the insights. First, the investment behavior and financial performance of spun-off units improves following the spin-off. Gernter, Powers, and Scharfstein (2002) found that spun-off units tended to cut investment in unprofitable businesses and increase investment in profitable industries. Chemmanur and Paeglis (2001) found material increases in the price-earnings and price-sales ratios for parents and subsidiaries as a result of the transactions. Cusatis, Miles, and Woolridge (1993) documented significant returns over the longer term following spin-offs. Hurlburt et al. (2002) found that sales, assets, and capital expenditures of carved-out subsidiaries grew significantly faster than industry peers in the first year after the transaction; but the parent firm shrank. Ahn and Denis (2001) reported that diversified firms improved their investment efficiency and eliminated the diversification discount following spin-offs. In contrast, Haushalter and Mikkelson (2001) found no material improvement in long-term performance following tracking stock or carve-outs.

Second, relatedness matters in the choice of transaction. Chemmanur and Paeglis (2001) found that carve-outs and spin-offs tend to involve business units that are less related to the core than do tracking stocks. McNeil and Moore (2001) reported that announcement returns are larger at the spin-off of unrelated businesses than related businesses.

Third, the findings are consistent with benefits of increased focus. Hite and Owers (1983), Schipper and Smith (1983), Daley, Mehrotra, and Sivakumjar (1997), and Desai and Jain (1998) argue that spin-offs resolve “information asymmetry” problems—these arise from the complexity of multidivisional firms and the lack of transparency for investors to monitor the managers. Krisnaswami and Subramaniam (1999) find that firms undertaking spin-offs have higher levels of information asymmetry and that these problems decrease after the spin-offs. Best, Best, and Agapos (1998) find that securities analysts significantly increase their short-term earnings forecasts after spin-offs. Daley, Mehrotra, and Sivakumar (1997) find significant value creation around cross-industry spin-offs (rather than same-industry spin-offs). Vijh (2000) reports higher carve-out returns when the subsidiary is in a different two-digit SIC code from the parent. Veld and Veld-Merkoulova (2002) report significantly higher returns at spin-offs that are focus-increasing.

EXHIBIT 6.17 Summary of Studies of Market Returns to Parent and Subsidiary Shareholders at Spin-Offs

Panel A: Returns to Shareholders of Parent
Study Cumulative Abnormal Returns at the Event Cumulative Abnormal Returns after the Event Sample Size Sample Periods
Davis, Leblond (2002) +2.92%* full sample +2.14%* industrial +3.87%* high tech (days –1,0) 93 1980–1999
Veld, Veld-Meruklova (2002) +2.66%* full sample +2.41% U.K. subsample +3.57% focus-increasing +0.76% not focus-increasing (days –1,+1) –0.41% full sample +5.20% focus-increasing –12.96%* not focus-increasing (months 0,+36) 200 1987–2000
Chemmanur, Paeglis (2001) +2.11%(days –1,+1) 19 1984–1998
McNeil, Moore (2001) + 3.53%* full sample +4.05%* unrelated +2.39% related (days –1,+1) 152 104 48 1980–1996
Desai, Jain (1999) + 3.8% +25.4% (3 yrs.) 155 1975–1991
Krishnaswami, Subramaniam (1999) +3.28%* full sample (days –1,+1) 118 1979–1993
Arbanell, Bushee, Raede (1998) + 3.23% return to parents –0.86% return to spin-off (days –1,+60) 245 1980–1996
Best, Best, Agapos (1998) +3.41%*announcement date +2.9g4%* ex-date (day 0) 72 63 1979–1993
Daley, Mehrotra, Sivakumar (1997) +3.4%* full sample +4.3%* focus-increasing +1.4% not focus-increasing 85 1975–1991
Parrino (1997) Clinical study of one spin-off by Marriott Corporation +13.19% announcement date +41.12% five event dates 1 1993
Johnson, Klein, Thibodeaux (1996) +3.96%* full sample +5.42%* “back to basic” subsample N/A 104 1975–1988
Slovin, Sushka, Ferraro (1995) +1.3% N/A 37 1980–1991
Cusatis, Miles, Woolridge (1993) N/A +12.5% (1 yr.) +26.7% (2 yrs.) +18.1% (3 yrs.) 146 1965–1988
Vijh (1994) +2.9% annct. date +0.79% completion date +3.03% ex-date 113 1964–1990
Rosenfeld (1984) +5.56%* full sample 35 1963–1981
Schipper, Smith (1983) +2.8% N/A 93 1963–1981
Hite, Owers (1983) +3.3% +7.0% (5 mos.) 123 1963–1981
Miles, Rosenfeld (1983) +3.34%* full sample (days –1,0) 22.9% (9 mos.) 55 1963–1980
Panel B: Returns to Shareholders of Subsidiary
Desai, Jain (1999) N/A + 15.7% (1 yr.) +36.2% (2 yrs.) +32.3% (3 yrs.) 155 1975–1991
Cusatis, Miles, Woolridge (1994) N/A +4.5% (1 yr.) +25.0% (2 yrs.) +33.6% (3 yrs.) 161 1965–1990

Unless otherwise noted, event date is announcement date of transaction.

*Significant at the 0.99 level or better.

Significant at the 0.90 level.

Significant at the 0.95 level.

EXHIBIT 6.18 Summary of Studies of Market Returns to Parent and Subsidiary Shareholders at Carve-Outs

Panel A: Returns to Shareholders of Parent
Study Cumulative Abnormal Returns at the Event Cumulative Abnormal Returns after the Event Sample Size Sample Period Notes
Vijh (2002) +1.94%* full sample +4.92%* sub is large +1.19%* sub is small (days –1,+1) 336 1980–1997 Tests reject the asymmetric information hypothesis and support the divestiture gains hypothesis.
Hurlburt, Miles, Wool ridge (2002) +1.92%* full sample +2.10%* cross-industry –0.39% own industry 185 153 30 1981–1994 Finds negative effect of carve-out announcement on rival firms.
Hogan, Olsen (2002) +11.42% carve-outs +16.53% IPOs matched (day 0) 219 1991–2000 Carve-out returns are lower than returns in a matched sample of IPOs at offering.
Schill, Zhou (2001) +11.3% (days –1,+1) 11 2000 Focus on carve-outs of Internet subsidiaries.
Haushalter, Mikkelson (2001) +3.39%* full sample (days –2,+2) 13 1994–1996
Hulburt, Miles, Wool ridge (2000) +1.9%* (days –1,0) 185 1981–1994
Vijh (2000) + 1.94%* full sample +2.25%* sub nor related industry +0.80% sub is related (days –1,+1) 336 221 100 1980–1997
Prezas, Tarimcilar, Vasudevan (2000) +5.83%* (day 0) 7.61%* (6 mos.) 11.75%* (1 yr.) 21.07%* (3 yrs.) 237 1986–1995 Carve-out returns are lower than returns in a matched sample of IPOs at offering and over the postoffering time periods.
Allen (1998) +33.2% HPR (0,12 months) +229.3% HPR (0,60) Holding period returns adjusted for industry returns 1 1983–1995 Clinical study of 11 carve-outs by Thermo Electric
Allen, McConnell (1998) +2.12%* full sample +6.63%* proceeds paid out –0.01% proceeds are retained (days –1,+ 1) 186 54 60 1978–1993
Slovin, Sushka, Ferraro (1995) +1.2%(days –l,0) 32 1982–1991
Klein, Rosenfeld, Beranek (1991) +2.75%* full sample 52 1966–1980
Schipper, Smith (1986) +1.83% subsidiary –3.5%* parent (days –4,0) –0.5% subsidiary –1.40% parent (days +1,+40) 76 1965–1983
Chemmanur, Paeglis (2001) +1.96% (days –1,+1) 19 1984–1998
Panel B: Returns to Shareholders of Subsidiary in Carve-Out
Hulburt, Miles, Wool ridge (1994) N/A +12.5% (1 yr.) +14.4% (2 yrs.) +24.7% (3 yrs.) 80 1981–1989

Unless otherwise noted, event date is announcement date of transaction.

*Significant at the 0.99 level or better.

Significant at the 0.90 level.

Significant at the 0.95 level.

EXHIBIT 6.19 Summary of Studies of Market Returns to Parent Shareholders at Creation of Tracking Stocks

Study Cumulative Abnormal Returns at the Event Cumulative Abnormal Returns after the Event Sample Size Sample Period
Haushalter, Mikkelson (2001) +3.00%* full sample (days –2,+2) 31 1994–1996
Billet, Vijh (2000) +2.67%* Parent company1.07% (1 yr.) –5.77% (2 yrs.) –4.15% (3 yrs.) Tracking stock +9.74% (1 yr.) –15.26% (2 yrs.) —40.05% (3 yrs.) 20 1984–1998
Elder, Westra (2000) +3.1%* full sample (days –1,0) N/A 35 1984–1999
D’Souza, Jacob (1999) +3.61%* full sample (days –1,+1) 64 1984–1997
Logue, Seward, Walsh (1996) +2.9% (days –1,0) N/A 8 1985–1994
Chemmanur, Paeglis (2001) +3.09%* (days –1,+1) 19 1984–1998

Unless otherwise noted, event date is announcement date of transaction.

*Significant at the 0.99 level or better.

Significant at the 0.95 level.

Fourth, the types of transactions do differ in their effects. Though the diagrams in Exhibit 6.14 suggest a strong similarity in their resulting structures, in fact the transaction types have materially different impacts: Tracking stocks do not result in increased focus, tax, or regulatory benefits, only increased transparency. Split-offs alter the ownership of the parent; carve-outs, like divestitures, change the ownership of the subsidiary. In a spin-off, no new funds flow to the parent—Anderson (2002) finds that the need to raise additional capital is significant in explaining the type of transaction chosen. Parrino (1997) documents a major transfer of wealth from bondholders to stockholders from a spin-off effected by Marriott Corporation. The variation in returns across transaction type could be explained by any of these factors: agency costs, internal capital markets, information, control, and so on. Notwithstanding the differences among the forms of these transactions, abnormal returns from these transactions are generally consistent: spin-offs return roughly 2 to 4 percent, compared to carve-outs of 2 to 3 percent, and tracking stocks of 3 percent.

Fifth, as with divestitures, deployment of funds raised in these transactions makes a difference. Allen and McConnell (1998) found a large difference in announcement day returns: Investors reacted positively to carve-outs that would generate cash to be paid to creditors; instances where the funds were to be reinvested in the business were met with zero response from investors.

Sixth, the restructuring has an impact on the rivals of the firm. Hurlburt et al. (2002) found that the effect of carve-out announcements on the returns of rival firms was significantly negative.

Seventh, the timing and type of the restructuring seems to be associated with the valuation of the parent and subsidiary in the capital markets. Nanda (1991) suggests that opportunistic behavior by managers will motivate them to favor carve-outs over divestitures when the parent’s shares are relatively undervalued and the subsidiary’s shares are relatively overvalued. Thus, a sale of equity in the subsidiary would become a signal to investors of the parent’s undervaluation. The findings on carve-out announcement returns in Exhibit 6.18 generally support such a hypothesis. For instance, Schill and Zhou (2001) write, “Overall, the evidence can best be explained with models where clienteles of investors with optimistically biased expectations drive the prices of subsidiaries above parent valuations and arbitrage costs prohibit market forces from eliminating the disparity between parent-subsidiary valuations.” (Page 27)

The hypotheses about the sources of gains from restructuring center predominantly on two: an agency cost argument that increased focus cures ills of internal capital markets; and hypotheses about exploiting misvaluations in the market. These hypotheses are not mutually exclusive. But the research supports the existence of both sources, giving, perhaps, more weight to the agency cost hypothesis on the grounds of the number of studies confirming the value of corporate focus.

Applied Mergers and Acquisitions

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