Cablevision Goes “Sundancing”

Will GE, Showtime, or Robert Redford spoil the tax-free treatment of the Cablevision-Sundance Channel deal?

On May 7, 2008, Rainbow Media Holdings LLC, a programming subsidiary of Cablevision Systems Corp., announced that it had reached an agreement to acquire the Sundance Channel from General Electric Co.’s NBC Universal, CBS Corp.’s Showtime Networks, and entities controlled by none other than Robert Redford.

The structure of this $496 million deal is rather unusual. Under the terms of the transaction, the total consideration will be paid through a tax-free exchange of approximately 12.7 million shares of common stock of GE held by Rainbow Media, with a “cash adjustment” at closing based upon the value of the GE shares in relation to the total purchase price. Under the transaction structure, GE will receive the GE shares held by Cablevision, and CBS and Redford will receive cash in exchange for their interests in the Sundance Channel.

Split-Off

There is only one way to make sure the deal, which involves a swap of Cablevision’s GE shares for GE’s shares in the Sundance channel, would qualify as a tax-free exchange — configure it as a “split-off” that meets the requirements of Section 355 of the Internal Revenue Code. The exchange constitutes a split-off only if, among other things, GE is in control of the Sundance Channel immediately before the stock distribution.

For this purpose, control is defined by Section 368(c) , and means ownership of stock possessing at least 80 percent of the total combined voting power of all share classes entitled to vote, and 80 percent of the total number of shares of each class, if any, of the non-voting stock. (See Revenue Ruling 59-259, 1959-2 C.B. 115.)

Accordingly, we can surmise that GE, which only owns 57 percent of the value of the Sundance Channel’s stock, must own stock possessing at least 80 percent of the total combined voting power of Sundance’s outstanding stock. Presumably, the Sundance Channel is capitalized with two classes of stock — a high-vote class and a low-vote class. Further, we can also assume GE possesses a sufficient number of shares of the high vote class to provide it with the requisite percentage of the total combined voting power of all classes of Sundance stock entitled to vote.

In addition, it’s likely that the distribution of stock will not be characterized as a disqualified distribution within the meaning of Section 355(d). A disqualified distribution is one in which after distribution any person (Cablevision) holds a 50 percent or greater interest in either corporation (GE or the Sundance Channel) and the interest is attributable to disqualified stock. Disqualified stock are shared acquired by “purchase” within the five year period ending on the date of the distribution.

In the case of this most recent transaction, Cablevision acquired its GE stock in a tax-free exchange when it sold the Bravo Channel to NBC Universal. So long as five years have elapsed from the time Cablevision acquired the Bravo (by purchase or otherwise), Cablevision’s stock in GE will not constitute disqualified stock. As a result, the stock distribution by GE of the Sundance Channel to Cablevision will not be characterized as a disqualified distribution and, therefore, such distribution will remain eligible for tax-free treatment with respect to GE.

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