Spin-sanity

Can't sell that ill-fitting subsidiary or launch an IPO? The old tax-free spin-off may still be a good bet.

With the current market so dreadful for both initial public offerings and the outright sale of operations, what do you do these days if you need to cut a subsidiary loose?

As is often the case in market slumps, tax-free spin-offs have grown as a percentage of all divestitures being done.

These distributions to shareholders may have only limited allure in normal times; experts recognize them as among the least-profitable types of divestiture. Still, in this economy they may be about the only port in the storm for a company with that particular need. As a result, many companies have developed tax-free spin-off plans to make the best of the situation.

Take Allergan Inc., of Irvine, California, which in June spun off Advanced Medical Optics (AMO), a division that makes contact lens supplies and ophthalmic surgery products. Late last year, says Allergan CFO Eric Brandt, the parent decided to separate AMO in order to focus on its pharmaceuticals business. “We have been transitioning to a pharmaceutical company,” he says. “It was clear that the [AMO] business wasn’t a part of the strategy,” even though its $540 million in sales was a third of Allergan’s annual volume. “The best thing to do was give it its own future.” (Examine tax efficiency at Allergan and other companies discussed in this article with the CFO PeerMetrix interactive scorecards.)

Other methods for granting AMO that independent future–an IPO or other initiative based on investor interest–had been severely impaired by the September 11 terrorist attacks and Wall Street’s ensuing plunge. “It was our view that it would be best for us to take control of the situation directly,” says Brandt. “That way we wouldn’t be subject to the vagaries of the market.”

A Decline in Altruism?

In the traditional tax-free spin-off, of course, a parent company distributes all the stock of a subsidiary to the parent’s existing holders in the form of a dividend. To win tax-free treatment from the Internal Revenue Service, the company must meet several specific criteria: most important, the parent must own at least 80 percent of the voting stock of the subsidiary. Proposed spin-offs follow one of two scenarios.

If a subsidiary already exists as a stand-alone business, with completely separate assets and debt, it typically takes on additional bank debt to pay off the parent with a “midnight dividend” in cash just before the spin-off occurs. The parent, which is entitled to recoup the unit’s basis, in this case may use the cash any way it sees fit.

More common, though, are deals like Allergan’s spin-off of AMO, involving a parent that shares assets and debt with a division. In such cases the parent first must form a subsidiary through a so-called Type D reorganization. In that process, the parent has a chance to both structure the subsidiary’s debt and adjust its own balance sheet.

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