Two Mergers Are Better than One

The seldom-used double-dummy structure is trotted out in one of the year's most talked-about deals.

For him and for other large shareholders that have a small basis, an all-cash buyout would have meant an enormous capital gain. The double-dummy structure provides tax-free treatment on the stock portion of the transaction, which is expected to be finalized early next year.

Top Priority

Clearly, Siebel’s tax bill was a top priority in this deal. In documents filed with the Securities and Exchange Commission, Oracle and Siebel call the tax-free double dummy an “inducement” for Thomas Siebel. Interestingly, in its yearlong buying spree, Oracle has spent billions to acquire 11 companies, including PeopleSoft. Other than Siebel, not one used the double-dummy scheme.

Here’s how a double dummy worked for Oracle and Siebel: First, the companies formed a new holding company. Thus, Ozark Holdings was created. Ozark then created two transitory subsidiaries, the so-called dummies. One will merge with Oracle, the other with Siebel Systems. Oracle and Siebel will survive the double-dummy mergers; the dummy companies will be shut down. Oracle shareholders will exchange their stock on a one-for-one basis, tax free, for stock in Ozark. Siebel shareholders will exchange their stock for cash or stock in Ozark (but no more than 30 percent of the consideration can be stock). Siebel’s shareholders will pay taxes only on the cash portion of the transaction.

The stock portions of the transactions qualify as tax free under Section 351 of the Tax Code, which is not bound by the continuity-of-interest rule of Section 368. However, Ozark must remain in place permanently. Terminating the holding company would jeopardize the tax-free nature of the deal. That’s because Section 351 requires that the tax-free stock transfer between Ozark Holdings and the two operating companies be substantive in nature, notes Mark Boyer, a tax attorney with PricewaterhouseCoopers.

Thomas Siebel could have achieved tax savings on a more common deal structure: a tax-free reorganization under Section 368. But under this structure, Siebel and other shareholders would have had to take at least 40 percent of the compensation in stock. It might have been a good deal for them, but it would have punished Oracle shareholders by diluting earnings per share beyond an acceptable level. Structured as the deal is now, with stock consideration limited to 30 percent of the merger’s total value, dilution of Oracle’s earnings per share will be modest, even if the Siebel stock payout reaches the full 30 percent.

Sometimes, double dummies are built into deals as a sort of safety net. Investment bankers have structured some mergers with a trigger that activates a double dummy under certain conditions. That ensures tax savings in volatile situations, but allows for a simpler deal structure when possible. Witness the $3.1 billion acquisition of Mitchell Energy & Development Corp. by Devon Energy Corp. in 2002. Devon offered a 50-50 cash and stock buyout of shareholders in Mitchell Energy. George Mitchell and his family, who owned 47 percent of Mitchell Energy, insisted that the transaction be structured to ensure that Devon common stock received by shareholders would be tax-free.


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