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

Mandatory Exchangeable Notes – Key Structuring Issues

• 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

Standard Exchangeable Notes – Key Structuring Issues

• 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

Transaction Structure

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