Monetizing Spin-Off

• P contributes S (or the relevant division) to NewCo, the entity to be taken public in exchange for 100% of NewCo equity and a NewCo Note⁽¹⁾
  • NewCo can also assume P debt in an amount up to P’s tax basis in the contributed assets or, alternatively, can borrow and upstream cash to P via a dividend of the same amount
  • The total amount of debt pushed down to NewCo through issuance of the NewCo Note, assumption of P debt, and/or incurrence of new debt is limited only by NewCo’s debt capacity
• Contribution of S to NewCo qualifies the transaction as a reorganization under Section 368(a)(1)(D); such a structure increases flexibility to retire short-term debt in connection with the spin-off and facilitates the retirement of P debt with the NewCo Note

• Investment bank buys short-term debt of P (e.g. P’s commercial paper) for cash on the secondary market⁽²⁾
• At the time of such acquisition, the investment bank and P have a prearranged plan, but no binding contract, to exchange NewCo shares (in a debt-for-equity exchange) and NewCo Note (in a debt-for-debt exchange) for P debt
• The investment bank must hold such debt for a certain time period (e.g. 14 days) prior to contracting to execute the Debt/Equity and Debt/Debt Swaps
• Current IRS position: Exchange agreement permissible after 5 days; pricing determined 9 days later

• Investment bank sells NewCo shares to the public in a public offering. All or a portion of these shares are received by the bank from P in retirement of a portion of the P short-term debt, and then sold to the public. The remainder, if any, are directly issued by NewCo (through the investment bank) in a primary share offering
• Alternatively, the investment bank could sell the shares as part of a demand event for the subsidiary’s equity other than a public offering (e.g. admission of the subsidiary to the S&P 500 or merger of the subsidiary into a large public company)

Debt-for-Debt Exchange

• Investment bank also exchanges with P the remaining portion of the P short-term debt in exchange for the NewCo Note and re-markets the NewCo Note to new P bondholders

Cash Debt Retirement

• P uses any cash upstreamed from NewCo to retire existing P short-term debt

• P now has monetized S through (i) NewCo assumption of P debt (or distribution of new financing proceeds to P), (ii) retirement of P short-term debt through debt-for-debt exchange, and (iii) retirement of P short-term debt in a debt-for-equity swap
• Through these techniques, P can monetize over 50% of the enterprise value of the subsidiary being spun off

• P spins off remainder of NewCo common shares (representing at least 80% of the voting interest in NewCo) to the public shareholders of P

• Monetization is permanently tax-free and can be very substantial (subject to market capacity, over 50% of enterprise value of NewCo)
• Allows tax-free monetization or retirement of P debt in excess of P’s basis
  • Alternatively, conventional debt push-down is tax-free only to the extent of P’s basis
• Complete exit from the business
• Separate pure-play currency created (value enhancement to shareholders)

• Execution risk: market capacity for shares
• Incomplete monetization: some value leakage from the corporation
• Morris Trust rules apply to subsequent acquisitions causing a change-in-control of either the spun-off or distributing company
• Necessary to effect “D” reorganization (however, low threshold to qualify)