1 AS A FINANCIAL INSTRUMENT FOR CORPORATE RESTRUCTURING, WILL IT WORK FOR THE PULP AND PAPER INDUSTRY? V.R. (PERRY) PARTHASARATHY, PhD WEYERHAEUSER COMPANY PORT WENTWORTH, GA TAPPI Engineering, Pulping and Envirnmental Cnference, Jacksnville, Flrida, USA Octber 21 t 24, 2007
2 BREAKING UP IS GOOD TO DO. Restructuring thrugh spin-ffs and equity carve-uts can enhance Sharehlder Value Creatin (SVC)
3 Restructuring usually eliminates diffusin f management gals, a prblem that ges hand in hand with big, diversified cmpanies. When the aim is t fcus n being the best at ne r tw things, restructuring make sense. Spin-Offs (SO) and Equity Carve-Outs (ECO) are used by large crpratins fr restructuring purpses. Used judiciusly, SO and ECO are imprtant financial instruments that help crpratins increase value.
4 CORPORATE EQUITY CLAIMS There are three types f crprate equity claims: Tracking (r Targeted) Stck (TS), Majrity-wned Equity Carve-Out (ECO) and Spin-ffs (SO).
5 CORPORATE EQUITY CLAIMS The Tracking Stck (TS) is a class f cmmn stck that is linked t the perfrmance f a specific business grup within the diversified firm. Equity Carve-uts (ECO) are an IPO f a stake in a subsidiary. The parent usually keeps majrity wnership. Spin-ffs (SO) ccur when the entire wnership f a subsidiary is divested as a dividend t sharehlders.
6 TRACKING STOCK (TS) The financial reprting is separate fr the TS frm the parent but the cntrl remains in the hands f the parent cmpany. TS is typically distributed as a dividend t sharehlders f the parent cmpany and can als take the frm f an Initial Public Offering (IPO). Even during its hay day, nly tw Pulp and Paper Cmpanies had taken advantage f this instrument but that did nt result in the enhancement f their crprate value. By 2006, the TS as a crprate restructuring tl had disappeared altgether and nne was issued between 2001 and 2006.
7 The ECO is different frm TS in that equity partitin creates welldefined equity claims n assets. ECO is the sale f a subsidiary by a publicly traded cmpany by carving ut a prtin f its utstanding shares thrugh IPO. While the parent firm usually retains a cntrlling interest in the partitined subsidiary, each ECO, hwever will have its wn bard, perating CEO, and will issue its wn financial statement. Equity Carve-Outs (ECO) increase the access t capital markets, enabling ECO subsidiary strng grwth pprtunities while aviding the negative signaling assciated with a seasned ffering (SEO) f parent equity.
8 In a twelve-year perid between 1988 and 1999, the US stck market has seen 50 Carveuts, r abut 10% f the IPOs issued. While the number f IPOs issued had increased at least three fld between the years 1997 and 2006, the IPOs fr ECO were nt that many (Exhibit 1). Over the years, ECO as a crprate restructuring vehicle has shifted, fr financial gain t strategic realignment. Percent Strategic Reasns Financial Reasns Strategic Reasns Financial Reasns EXHIBIT 1. The Trend in Asset Disaggregatin Number f Events 100% 80% 60% SPIN-OFF EQUITY CARVE-OUT (ECO) % 20% Surce: Blmberg, Financial Executives Research Fundatin, Cmpustat Inc., Cmpustat SDC, BDCI SDC, Analysis BDCI Analysis
9 One thing sure abut ECO is the inherent assumptin that the asset that is being carved-ut culd nt derive its full asset value under the existing crprate structure and a carve-ut will accurately value the subsidiary if, part f the equity is carved ut and sld in an IPO (Exhibit 2). EXHIBIT 2. Equity Carve-Out (Prs and Cns)
10 Cmmn equity is the cheapest yet the largest value distributin in the Enterprise Valuatin f a cmpany with multiple business segments. ECO gives a crprate parent an pprtunity t get equity and at the same time increase its market capitalizatin by virtue f restructuring ne f the units as a carved-ut entity TOTAL = 2000 Cnvertible Securities Operatin D Crprate Overhead 1750 *all values in millin US$ 400 Debt EXHIBIT 3. Valuatin f an Enterprise with Multi-Business Segments 350 Operatin C 450 Operatin B 750* Operatin A Preferred Stck Cmmn Equity Stck Value f the Enterprise Value Operating Units Value Distributin Surce: Valuatin Measuring and Managing the Value f Cmpanies: McKinsey & Cmpany, Inc.,
11 Therm-Electrn (TE) is the mst successful cmpany t leverage ECO t deliver high returns t its sharehlders. In 1982, TE was just a US $200 millin cmpany. By 1997, its market value was $5200 millin (a whpping 2500%) thrugh frequent equity partitin f business segments and wning cntrlled interest in the ECO subsidiaries EXHIBIT 4. Therm Electrn s ECO Examples
12 Equity Carve-Outs (ECO) ut perfrmed SO n three financial metrics, Ttal Sharehlder Return (TSR), change in leading P/E rati and Return n Invested Capital (ROIC). EXHIBIT 5. Cmparisn f Perfrmance Metrics fr ECO and SO
13 The Bz-Allen & Hamiltn and SMU/The McKinsey Cmpany studies which cmpared 78 merger deals between 1997 and 1998 and between 2002 and 2003 and wrth mre than $1 billin each, cncluded that 48% f the mergers failed t deliver the prmised cst savings ver the tw-year pst-merger perid. 52 percent f them had fallen shrt f achieving the revenue grwth. Almst ne-third f the cmpanies delivered less than 40% f the cst-savings that were used as the basis fr the mergers. The previus pulp and paper industry mergers (and the premiums paid t acquire the cmpanies) had been justified under ptential cst savings rather than revenue grwth put a big dent n their chance fr success which came ut t be true.
14 Pre-Merger Revenue Grwth EQUITY CARVE-OUT (ECO) ECO n average has the strngest TSR r SVC perfrmance f any restructuring vehicle and the track recrd f ECO n ROIC are far superir t Spin-ffs (SO). Psitive Slw Dwn f Slid Perfrmers 4 3 Great Earners Unfazed 2 EXHIBIT 6. Very Few Cmpanies Achieved Success Thrugh Mergers Bad Remains Bad Negative -3 Very Few Players Perfrm Negative Pst-Merger Revenue Grwth Psitive Sample f mre than 160 acquisitins by 157 publicly traded cmpanies acrss 11 industries. Revenue grwth calculated fr cmbined entity 5 years befre and after mergers ( ) Surce: The McKinsey Quarterly 2001, Number 4.
15 T deliver superir sharehlder return, P&P industry can use, ECO as a crprate restructuring vehicle. Fr ECO t be successful, the parent cmpany shuld have multi-segmented businesses and that the subsidiary can be separated easily frm the parent withut creating huge transfer-pricing issues and als the subsidiary shuld have gd prspects. Out f the eighteen large U.S. and Canadian pulp and paper cmpanies, nly six are truly multi-segmented businesses and nly these cmpanies can d an ECO r spin-ff.
16 The majrity-wned ECO is the mst apprpriate fr P&P industry because: Out f the six P&P cmpanies that are truly multi-segmented businesses, five f them have debt t equity rati ver 1.5 and therefre suffer huge capital cnstraints. ECO will allw the parent cmpanies t raise capital at a fair-price and t fund prjects that might therwise depress earnings.
17 The majrity-wned ECO is the mst apprpriate fr P&P industry because: Certain businesses in pulp and paper cmpanies, wdlands r lumber, fr example, can readily be separated withut invlving transfer price prblems. Befre the ECO, bth the bards need t review cntractual agreements, including thse establishing transfer prices, and agree n sharing ther supprts such as R&D, sales and marketing, and certain manufacturing resurces, etc.
18 CONCLUSIONS Restructuring f crpratins is usually carried-ut t imprve perfrmance. A majrity-wned equity carve-ut is ne such equity claim that wuld allw the carved-ut business units t imprve perfrmance by expsing them t the capital market and attracting new investrs. ECO brings a new management team int the rganizatin. This usually results in imprvement in perating perfrmance, prviding incentives fr managers and increasing their strategic flexibility.
19 CONCLUSIONS While mergers can be used as ne f the tls t imprve the perfrmance f the pulp and paper industry, fr cmpanies with multi-segmented businesses, the ECO ffers the best valueenhancing prpsitin If judiciusly applied, ECO can help crprate management t increase value f bth the parent and the carved-ut subsidiary.
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