Stock-for-Stock Monetization

Overview

Frequently, a seller of a business will receive publicly traded shares of the buyer as part of a tax-free stock-for-stock exchange. The structures set forth herein allow the seller to monetize such shares in a tax-efficient manner
To monetize the shares received in the exchange, the seller can enter into a derivative capital markets transaction or a derivative with its investment bank; examples of such are as follows:
- Mandatory Exchangeable Notes: A security issued by the Seller (i.e. holder of the Buyer’s shares) that mandatorily converts into Buyer shares after a designated period (usually 3-5 years); at the time of the mandatory exchange, the Seller incurs tax as if it had sold its Buyer shares
- Standard Exchangeable Notes: A security issued by the company which is exchangeable, at the holder’s option, into shares of the buyer; the term of the exchangeable security can be up to 30 years, allowing the company to accomplish tax deferral over a more significant period of time
- Collar Coupled with Loan: Seller enters into a put and call arrangement with its investment bank hedging its risk on buyer’s shares and borrows against hedged position. Hedge can typically be put on for up to a 10-year deferral period
In addition to these strategies, the investment bank can develop a monetization strategy tailored to the Seller’s particular tax, accounting, and regulatory objectives
Precedent transactions: Liberty/Media One

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3-5 year non-callable debt securities, which mandatorily exchange into underlying Buyer common stock, or its cash equivalent, at maturity at the Seller’s option
- At maturity, the number of Buyer shares delivered is calculated using the 20-day share price average
- The value due to investors at maturity can be either cash or stock settled; investor has no conversion option
Senior Note is an obligation of the Seller
- Seller maintains ownership of underlying Buyer shares
Number of shares delivered at maturity varies depending on the buyer’s stock price such that the Seller retains all of the first 20% of stock price appreciation and 17% of all subsequent appreciation
Quarterly coupon payments are higher than the underlying Buyer common stock dividends to compensate investors for giving up a portion of the upside

Exchangeable notes rank as Seller senior debt, typically issued at 100% of face amount, although can be structured on an original issue discount (“OID”) basis
Exchangeable into a fixed number of underlying Buyer common shares
Conversion premium remains fixed throughout life
Generally callable after 3 years, but the non-call period can be extended and result in more aggressive pricing
If not converted, the principal amount is redeemed in full by the seller at maturity
The seller may keep a cash settlement option even if the note is in-the-money, but this may narrow buying universe
Can be structured with high conversion premium and correspondingly high coupon

Step 1 – Stock-for-Stock Exchange
	Buyer acquires Sub shares from Seller in exchange for Buyer common or convertible preferred stock If Buyer convertible preferred stock is utilized, must constitute participating preferred stock of long-term preferred stock (i.e. maturity of at least 20 years) to qualify as tax-free to Seller
Step 2 – Monetization
	Seller enters into a derivative capital markets transaction or a derivative with its investment bank with respect to its Buyer shares, which monetizes the shares without triggering any current tax liability

	Advantages	Disadvantages
Mandatory Exchangeable	Seller maintains ownership of Buyer shares until conversion Receives dividend and has voting rights Captures Dividends Received Deduction Certainty of sale at current market price of higher while taxable event deferred until shares sold or delivered	High coupon costs Interest is likely to be capitalized into basis in shares under Straddle Rules Hedge Accounting – possible to structure with no mark-to-market mismatch
Standard Exchangeable	Seller maintains ownership of Buyer shares until conversion Receives dividends and has voting rights Captures Dividends Received Deduction Provides for long-term deferral of capital gains taxes on appreciated shares	Not a definitive sale of Buyer shares Longer-term structures will result in high coupons or lower conversion premiums Interest is likely to be capitalized into basis in shares under Straddle Rules Under FAS 159, possible to mark-to-market instrument with underlying asset to avoid mismatch caused by earnings volatility

Alternative	Risk Transfer	Monetization	Tax	Accounting	Credit
Mandatory Exchangeable	Complete elimination of downside exposure; some retained upside interest	Full	Deferral for 3-5 years; interest capitalized in excess of yield on underlying security	Hedge accounting available; little earnings volatility	Little net credit impact
Traditional Exchangeable	Some retained upside interest; full downside exposure	Full	Deferral for 5-30 years; interest capitalized in excess of yield on underlying security	FAS 139 permits mark-to-market election; little earnings volatility	Substantial credit impact (on balance sheet financing)
Collar/Loan	Small upside interest and downside exposure (i.e. within collar)	Less than full (ability to leverage non-recourse against asset)	Deferral for term of collar/loan, typically 1-5 years; interest capitalized in excess of yield on underlying security	Hedge accounting available; little earnings volatility	Little net credit impact (non-recourse loan)

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