For all the hard-charging, high-flying, death-defining bravado that Marvel comic characters exude, the corporate union between Marvel Entertainment and The Walt Disney Co. is anything but splashy. In fact, from a tax perspective, it is as risk-averse as, well, Snow White. A look at the deal details explains why.
On August 31, Disney agreed to acquire Marvel in a stock and cash transaction. The move unites a cavalcade of big revenue-generating animated characters, bringing together, for example, Disney’s Mickey Mouse and Lion King with Marvel’s Spiderman and X-Men.
Marvel shareholders would receive a total of $30 per share in cash, plus approximately 0.745 Disney shares for each Marvel share they hold. The parties intend that the acquisition, which will be structured as a forward merger, qualify as a tax-free reorganization within the meaning of the Tax Code’s Section 368(a)(1)(A).
For the deal to be considered a reorganization, the transaction must exhibit the requisite continuity of interest (COI). It will, if a “substantial part” of the value of the proprietary interests in the target is preserved in the transaction. Indeed, a proprietary interest is preserved if it is exchanged for a proprietary interest in the issuing corporation.
On the other hand, a proprietary interest is not preserved if, in connection with the potential reorganization, it is acquired by the issuing corporation for consideration other than stock (such as notes or cash).
It is now clear that as little as 40% represents a substantial part of the whole. As a result, for COI to be satisfied, at least 40% of the aggregate consideration conveyed by Disney must be comprised of its stock.
“Interestingly, the signing date rule was supposed to address what Disney and Marvel are being extremely careful about.” — Robert Willens
Signing Date Rule
In determining whether a proprietary interest is preserved, the regulations state that the consideration to be exchanged must be valued on the last business day before the first date the merger contract is a binding pact — if the contract stipulates a fixed consideration. A contract stipulates a fixed consideration if it provides the number of shares of each class of stock and the amount of money to be exchanged for all of the proprietary interests in the target, or for each proprietary interest therein.
In this case, if the consideration to be exchanged consisted of 0.745 Disney shares plus $30 in cash for each Marvel share, it would appear that under the so-called signing date rule, COI would be satisfied.
The closing price of Disney’s stock on August 28, 2009 (the last business day before the first date the contract was a binding contract) was $26.84. That means, precisely 40% of the consideration to be exchanged would consist of stock, with the result that a substantial part of the value of the proprietary interests in Marvel would be preserved.
But the dealmakers left nothing to chance with respect to obtaining tax-free status, and included in the transaction an adjustment mechanism. Additional stock (and presumably less cash) may be issued for the purpose of insuring that, as of the effective time, at least 40% of the consideration, by value, consists of Disney stock.
Interestingly, the signing date rule was supposed to address what Disney and Marvel are being extremely careful about: the possibility that COI might be unwittingly flunked solely based on declines in the value of the issuing corporation’s stock during the period bounded by the date of announcement and the date on which the merger was actually consummated.
So it appears that the adjustment mechanism is unnecessary, at least for COI purposes.
It may be that the Marvel shareholders insisted on the mechanism out of an abundance of caution. Clearly, there can be no issue regarding the transaction’s compliance with the COI principle if the value of the stock to be conveyed represents at least 40% of the aggregate consideration both on the date on which the deal was announced and on the date on which it is finally consummated.1
Robert Willens, founder and principal of Robert Willens LLC and CFO contributing editor, writes a weekly tax column for CFO.com.
1The transaction could have been structured as a so-called horizontal double dummy arrangement; the attraction being that there is no COI requirement. Thus, there is no need, in a double dummy transaction, to ensure that some minimum percentage of the aggregate consideration consists of stock.