Monetizing Spin-Off

• A monetizing spin-off is a structure which allows a Seller to spin off a subsidiary on a fully tax-free basis while de-leveraging to a very significant extent
• Basic Spin-Off Paradigm: Typically, a company spinning off a Subsidiary can upstream cash from the subsidiary on a tax-free basis, or push down debt to the subsidiary, only to the extent of its tax basis in the subsidiary. Any incremental cash received/debt pushed down would trigger a taxable gain upon completion of the spin-off, as would other techniques to get cash proceeds to Seller (e.g. a secondary sale of Subsidiary equity prior to the spin-off)
• Key Concept of Monetizing Spin-Off: The monetizing spin-off allows the Seller to gain incremental value above and beyond its basis through two core strategies: (i) a Debt/Equity Swap, in which the Seller utilizes a portion of the subsidiary shares to retire its own debt (in lieu of distributing the shares to its stockholders in the spin-off) and (ii) a Debt/Debt Swap, in which the Seller retires incremental amounts of its own debt by exchanging it for debt of its subsidiary
• Such transactions, which would normally generate a tax liability to the Seller, are tax-free when implemented as part of a spin-off
• Such transactions can be implemented as part of (i) a straight spin-off, (ii) a Morris Trust or reverse Morris Trust transaction, or (iii) a pre-spin-off IPO carve-out
• Two monetizing spin-off structures:
  1. Conventional Monetizing Spin-Off: In a conventional monetizing spin-off, an investment bank facilitates the debt/equity and debt/debt swaps by purchasing Seller debt securities in the market and exchanging them for Subsidiary equity or debt securities. The bank then markets the Subsidiary securities as part of a public offering or other demand event (e.g. sale of subsidiary shares to index funds required to make such purchase upon admission of Subsidiary to the S&P 500)
     • The debt/equity swap component is limited by the market receptiveness to and capacity for a sale of Subsidiary equity securities. The debt/debt swap component is limited by the subsidiary's debt capacity
     • A debt/equity swap by necessity occurs as part of a larger demand event with respect to the Subsidiary's equity. Examples include a pre-spin-off IPO carve-out (e.g. Lucent/Agere), the admission of the Subsidiary to the S&P 500 (AT&T Wireless) or the merger of the subsidiary into a larger public company
     • A pre-spin-off IPO carve-out can be executed entirely as a debt/equity swap, whereby the underwriter effectively "buys" the shares to be placed in the offering utilizing parent company debt as the sole consideration
       • As long as the IPO carve-out is an integrated part of a plan to spin off the Subsidiary, the fact that the carve-out occurs as much as 12 months prior to the actual spin-off does not taint the tax-free treatment of the swap
  2. Sponsored Spin-Off: In a sponsored spin-off, a financial sponsor acquires up to 49.9% of SpinCo as part of the monetizing spin
• Precedent transactions: Verizon/Idearc, Alltel/Windstream, Sprint/Embarq, Lucent/Agere, AT&T/AT&T Wireless

Transaction Structure

Step 1	Transaction Steps
	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
Step 2	Transaction Steps
	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
Step 3	Transaction Steps
	Debt-for-Equity Exchange 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
Step 4	Transaction Steps
	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
Step 5	Transaction Steps
	P spins off remainder of NewCo common shares (representing at least 80% of the voting interest in NewCo) to the public shareholders of P