Cablevision Shoots for an MSG Spin-off

The cable television giant sets a date to divest its Madison Square Garden network in what appears to be a tax-free transaction.

Cablevision intends to spin off the stock of its Madison Square Garden Inc. (MSG) subsidiary on February 9, 2010. On that date, holders of Cablevision’s Class A stock will receive, with respect to each share, one-quarter of a share of MSG’s Class A stock. Similarly, holders of Cablevision’s Class B stock will receive one-quarter of a share of MSG’s Class B stock with respect to each share. Further, Cablevision will pay cash in lieu of issuing fractional shares.

In addition, Cablevision has asked for, and received, a ruling from the Internal Revenue Service related to the spin-off and whether the arrangement qualifies as a tax-free transaction under the tax code — specifically Section 368(a)(1)(D) and Section 355. However, the IRS does not rule with respect to certain aspects of spin-offs. For example, it does not rule on whether the distribution is carried out for a corporate business purpose, whether the transaction is used principally as a “device” for the distribution of earnings and profits, or whether an acquisition occurring in connection with the spin-off is part of a plan (or series of related transactions) that includes such spin-off. Accordingly, to fill the information void, Cablevision is also securing an opinion of counsel regarding the tax-free nature of the spin-off.

Increase the Stock Price

For a spin-off to be tax-free, it must be carried out for one or more corporate business purposes. The business purpose must be a real and substantial non-Federal tax purpose that is germane to the business of the parent, the distributed subsidiary, or the affiliated group to which the parent belongs.

In Cablevision’s case, the principal business purpose for the separation is “to increase the aggregate value of the stock of Cablevision and MSG” so that after the distribution, each company can use its stock to achieve strategic objectives, such as effecting acquisitions, raising capital, or increasing the attractiveness of equity compensation plans with significantly less dilution to existing shareholders.

This is a well-accepted business purpose for a separation. Indeed, the IRS announced its approval of such a business purpose in a 2004 revenue ruling.1 In the ruling, a corporation that conducted two businesses separated them via a spin-off on the advice of its investment bankers. The bankers had opined that if each business were conducted in a separate and independent corporation, “the stock of the two likely would trade for a higher price in the aggregate, than the stock of the parent.” The company expected the increase in the stock price would enhance the value of its equity-based compensation plans, and also anticipated that the increase would permit it to effect acquisitions in a manner that preserved capital with significantly less dilution of the existing shareholders’ interests.

WillensFinal“Clearly, Cablevision’s separation fits within this published revenue ruling, and it seems certain that its spin-off of MSG will pass muster under the business-purpose doctrine.” — Robert Willens

The revenue ruling concludes that the separation was carried out for a corporate business purpose. The thinking was as follows: although a shareholder purpose for a separation is not a corporate business purpose (and here, the increase in the stock price is expected to confer a benefit to the shareholders), a shareholder purpose may be “so nearly co-extensive” with a corporate business purpose as to preclude any distinction between them. In such a case, the distribution is carried out for a corporate business purpose.

The ruling further concluded that, related to Cablevision, the shareholder purpose and the corporate business purpose were sufficiently co-extensive. Therefore, even though the separation accomplishes a shareholder purpose, it is regarded as carried out for a corporate business purpose.

Clearly, Cablevision’s separation fits within this published revenue ruling, and it seems certain that its spin-off of MSG will pass muster under the business-purpose doctrine. In addition, the separation will accomplish other business purposes: it will facilitate borrowing by Cablevision, reduce its financing costs, and achieve a degree of “fit and focus” — which is an IRS business-purpose criterion.

As in all spin-off transactions, there are certain restrictions imposed on MSG’s ability to issue stock and make acquisitions, or to be acquired during the post-spin-off period. However, these restrictions can be waived if Cablevision receives an opinion of counsel that such actions will not adversely affect the tax-free nature of the prior spin-off. We would assume that such an opinion could be secured fairly easily.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

Footnote
1 Revenue Ruling 2004-23, I.R.B. 2004-11, 2/13/04.

 

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