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Chapter 16: Alternative Exit and Restructuring Strategies
Divestitures, Spin-Offs, Carve-Outs, Split-Ups, and Split-Offs
Examination Questions and Answers
1. Divestitures, spin-offs, equity carve-outs, split-ups, and bust-ups are commonly used strategies to exit businesses.
True or False
2. Empirical studies show that the desire by parent firms to increase strategic focus is an important motive for exiting
businesses. True or False
3. Antitrust regulatory agencies may make their approval of a merger contingent on the willingness of the merger
partners to divest certain businesses. True or False
4. In deciding to sell a business, a parent firm should compare the business’ after-tax value in sale with its pre-tax value
to the parent as part of the parent.
True or False
5. The timing of a divestiture is important. If the business to be sold is highly cyclical, the sale should be timed to
coincide with the firm’s peak year earnings. True or False
6. A spin-off is a transaction involving a separate legal entity whose shares are sold to the parent firm’s shareholders.
True or False
7. A spin-off is a transaction in which a parent creates a new legal subsidiary and distributes shares it owns in the
subsidiary to its current shareholders as a stock dividend. True or False
8. In a spin-off, the proportional ownership of shares in the new legal subsidiary is the same as the stockholders’
proportional ownership of shares in the parent firm. True or False
9. In a spin-off, the board of directors is the same as the board of directors of the parent firm. True or False
10. A split-up involves the creation of a new class of stock for each of the parent’s operating subsidiaries, paying current
shareholders a dividend of each new class of stock, and then dissolving the remaining corporate shell. True or False
11. Spin-offs are generally immediately taxable to shareholders. True or False
12. Both a divestiture and a spin-off generally generate a cash infusion for the parent. True or False
13. Equity carve-outs have some of the characteristics of both divestitures and spin-offs. True or False
2
14. The parent firm generally retains control of the business involved in an equity carve-out. True or False
15. An equity carve-out is often a prelude to a complete divestiture of a business by the parent. True or False
16. Although the parent often retains control in an equity carve-out, the shareholder base of the subsidiary may be
different that that of the parent. True or False
17. In an equity carve-out, the cash raised by the subsidiary in this manner may be transferred to the parent as a dividend
or as an inter-company loan. True or False
18. When a parent creates a tracking stock for a subsidiary, it is giving up all control of that subsidiary. True or False
19. Tracking stocks are often created to give investors a pure play investment opportunity in one of the parent’s
subsidiaries. True or False
20. Tracking stocks may create internal operating conflicts among the parent’s business units in terms of how the
consolidated firm’s cash is allocated among its business units. True or False
21. Voluntary bust-ups or liquidations by the parent firm reflect management’s judgment that the sale of individual parts
of the firm could realize greater value than the value created by a continuation of the combined corporation. True or
False
22. In general, a voluntary bust-up or liquidation has the advantage over mergers of deferring the recognition of a gain by
the stockholders of the selling company until they eventually sell the stock. True or False
23. When a firm is unable to pay its liabilities as they come due, it is said to be in bankruptcy. True or False
24. Equity carve-outs are similar to divestitures and spin-offs in that they provide a cash infusion to the parent. True or
False
25. The divesting firm is required to recognize a gain or loss for financial reporting purposes equal to the difference
between the book value of the consideration received for the divested operation and its fair value. True or False
26. In a private solicitation, the parent firm may hire an investment banker or undertake on its own to identify potential
buyers to be contacted. True or False
27. A parent firm’s decision to sell or to retain a subsidiary is often made by comparing the after-tax equity value of the
subsidiary with the pre-tax and interest sale value of the business. True or False
28. A parent firm rarely chooses to divest an undervalued business and return the cash to shareholders either through a
liquidating dividend or share repurchase. True or False
29. The divestiture of a business always results in the parent receiving cash from the buyer? True or False
30. Management may sell assets to fund diversification opportunities? True or False
31. Many corporations, particularly large, highly diversified organizations, constantly are reviewing ways in which they
can enhance shareholder value by changing the composition of their assets, liabilities, equity, and operations. True or
False
32. Divestitures, spin-offs, equity carve-outs, split-ups, split-offs, and bust-ups are commonly used strategies to exit
businesses and to redeploy corporate assets by returning cash or noncash assets through a special dividend to
shareholders. True or False
33. Managing highly diverse and complex portfolios of businesses is both time consuming and distracting. This is
particularly true when the businesses are in largely related industries. True or False
34. A business that is rich in high-growth opportunities may be an excellent candidate for divestiture to a strategic buyer
with significant cash resources and limited growth opportunities. True or False
35. A substantial body of evidence indicates that increasing a firm’s degree of diversification can improve substantially
financial returns to shareholders. True or False
36. Empirical studies show that exit strategies, which return cash to shareholders, tend to have a highly unfavorable
impact on shareholder wealth creation. True or False
37. Acquiring companies often find themselves with certain assets and operations of the acquired company that do not fit
their primary strategy. Such assets may be divested to fund future investments. True of False
38. Divestitures always result in the parent receiving stock or debt from the buyer. True or False
39. The decision to sell or to retain the business depends on a comparison of the pre-tax value of the business to the parent
with the after-tax proceeds from the sale of the business. True or False
40. Although the sale value may exceed the equity value of the business, the parent may choose to retain the business for
strategic reasons. True or False
41. In a public solicitation, a firm can announce publicly that it is putting itself, a subsidiary, or a product line up for sale.
Either potential buyers contact the seller or the seller actively solicits bids from potential buyers or both. True or
False
42. In either a public or private solicitation, interested parties are asked to sign confidentiality agreements after they are
given access to proprietary information but before they are asked to make a bid. True or False
43. The divesting firm is required to recognize a gain or loss for financial reporting purposes equal to the difference
between the fair value of the consideration received for the divested operation and its market value. True or False
44. In a spin-off, some shareholders receive proportionately more shares than others. True or False
45. Like divestitures or equity carve-outs, the spin-off generally results in an infusion of cash to the parent company.
True or False
46. A split-up involves carving out a portion of the equity of each of the parent’s operating subsidiaries and selling the
shares to the public. True or False
47. Parent firms with a high tax basis in a business may choose to spin-off the unit as a tax-free distribution to
shareholders rather than sell the business and incur a substantial tax liability. True or False
48. Split-ups and spin-offs generally are taxable to shareholders. True or False
49. For financial reporting purposes, the parent firm should account for the spin-off of a subsidiary’s stock to its
shareholders at book value with no gain or loss recognized, other than any reduction in value due to impairment. True
or False
50. In an equity carve-out, minority shareholders are eliminated. True or False
51. Although the parent retains control, the shareholder base of the subsidiary that has undergone an equity carve-out is
unlikely to be different than that of the parent as a result of the public sale of equity. True or False
52. In addition, stock-based incentive programs to attract and retain key managers can be implemented for each operation
with its own tracking stock. True or False
53. For financial reporting purposes, a distribution of tracking stock splits the parent firm’s equity structure into separate
classes of stock without a legal split-up of the firm. True or False
54. Unlike a spin-off or carve-out, the parent retains complete ownership of the business for which it has created a
tracking stock. True or False
55. A disadvantage of a split-off is that they tend to increase the pressure on the spun-off firm’s share price, because
shareholders who exchange their stock are more likely to sell the new stock. True or False
56. Equity ownership changes in spin-offs, but it does not change in split-ups. True or False
57. The reasons for selecting a divestiture, carve-out, or spin-off strategy are basically the same. True or False
58. A spin-off is tax free to the shareholders if it is properly structured. In contrast, the cash proceeds from an outright sale
may be taxable to the parent to the extent a gain is realized. True or False
5
59. Restructuring actions may provide tax benefits that cannot be realized without undertaking a restructuring of the
business. True or False
60. Parent firms often exit businesses that consistently fail to meet or exceed the parent’s hurdle rate requirements. True
or False
61. Divestitures are always taxable to the selling firm? True or False
1. Which of the following is generally considered a motive for exiting businesses?
a. Changing corporate strategy or focus
b. Underperforming businesses
c. Regulatory concerns
d. Lack of fit
e. All of the above
2. To decide if a business is worth more to the shareholder if sold, the parent firm generally considers all of the
following factors except for
a. The after-tax cash flows of the business to be sold
b. The after-tax sale value of the business to be sold
c. The parent’s cost of capital
d. A and B
e. A, B, and C
3. Which of the following is not a characteristic of a spin-off?
a. The parent creates a new legal subsidiary for the business to be spun-off
b. The shares of the new subsidiary are sold to the public
c. The ownership of shares in the new legal subsidiary is the same as the stockholders’ proportional ownership
of shares in the parent firm
d. The new business once spun-off has its own management and board
e. Spin-offs are generally not taxable to the parent’s shareholders if properly structured
4. A spin-off may create shareholder wealth for all of the following reasons except for
a. Spin-offs are generally not taxable if properly structured
b. The spin-off’s management and board is independent of the former parent
c. Investors will be better able to value the spin-off
d. The cost of capital of the spin-off is generally higher than when it was part of the parent
e. The spin-off may be subsequently acquired by another firm
5. An equity carve-out differs from a spin-off for all but which one of the following reasons?
a. Generates a cash infusion into the parent
b. Is undertaken when the unit has very little synergy with the parent
c. The proceeds often are taxable to the parent
d. Continues to be influenced by the parent’s management and board
e. The carve-out’s shareholders may differ from those of the parent’s shareholders
6. Which one of the following is generally not a reason for issuing tracking stocks?
a. To give investors a “pure play” in a specific business owned by the parent
b. To create a currency for the business to acquire other firms
c. To enhance the likelihood that the business will be acquired
6
d. To create an incentive for management receiving the stock
e. To raise capital for the parent or for the business for which the tracking stock is created
7. For a spin-off to be tax-free to the shareholder it must satisfy which of the following:
a. The parent firm must have a controlling interest in the subsidiary before it is spun off.
b. After the spin-off, both the parent and the subsidiary must remain in the same line of business in which each
was involved for at least 5 years before the spin-off.
c. The spin-off cannot have been used as a means of avoiding dividend taxation by converting ordinary income
into capital gains.
d. The parent’s shareholders must maintain significant ownership in both the parent and the subsidiary
following the transactions.
e. All of the above
8. Which of the following is not true of a divestiture?
a. May create cash infusion for the parent firm
b. Parent ceases to exist
c. Proceeds of sale taxable if returned to shareholders through a dividend or stock buyback
d. A new legal subsidiary may be created
e. B and C
9. Which of the following is not true of a spin-off?
a. Creates cash infusion for parent
b. Change in equity ownership of the spin-off
c. New legal entity created
d. New shares issued to the public
e. A, B, and D
10. Which of the following is not true of an equity carve-out?
a. Creates cash infusion for the parent
b. Change in equity ownership of the unit involved in the carve-out
c. New shares issued to the public
d. Taxable if proceeds returned to shareholders through a dividend or stock buyback
e. Parent ceases to exist
11. Which of the following is true about a voluntary bust-up?
a. Parent ceases to exist
b. Cash infusion to the parent
c. Parent stock is exchanged for subsidiary stock
d. New shares issued to the public
e. Parent remains in control
12. Which of the following is generally not considered a common motive for exiting businesses?
a. Changing strategy or focus
b. Desire to achieve economies of scale
c. Lack of fit with the parent’s other businesses
d. Discarding unwanted businesses from prior acquisitions
e. All of the above
13. An equity carve-out by a parent of one of its subsidiaries is often a precursor to a
a. Complete divestiture or spin-off of the subsidiary
b. An acquisition
c. A merger
d. Joint venture
e. The creation of a tracking stock
14. Which of the following is a common problem associated with tracking stocks?
a. Tracking stocks often de-motivate managers of the business for which the stock is created
b. Such stocks are too complicated for investors to understand
c. Tracking stocks may create internal operating conflicts among the parent’s business units
d. Such stocks often create huge tax liabilities for the parent
e. None of the above
15. Which of the following is not true of a split-off?
a. A split-off is a variation of a spin-off
b. Parent company shareholders receive shares in a subsidiary in return for surrendering their parent company
shares
c. Split-offs are best suited for disposing of a less than 100 percent investment stake in a subsidiary,
d. A split-off reduces the parent firm’s earnings per share.
e. The split-off reduces the pressure on the spun-off firm’s share price
16. A diversified automotive parts supplier has decided to sell its valve manufacturing business. This sale is referred to as
a
a. Merger
b. Divestiture
c. Spin-off
d. Equity carveout
e. Liquidation
17. As part of its restructuring plan, a holding company plans to undertake an IPO for 35 percent of the shares it owns in a
subsidiary. The sale of these shares would be called a
a. Divestiture
b. Split-off
c. Split-up
d. Equity carveout
e. Breakup
18. A firm decides to distribute all of the shares it holds in a subsidiary to its shareholders. The distribution would be
called a
a. Divestiture
b. Split-up
c. Spin-off
d. Split-up
e. Equity carveout
19. The board of directors of a large conglomerate has decided that the investment opportunities for the firm are limited
and that greater value could be created for the shareholders if the firm were divided into four independent businesses.
Following approval by shareholders, the firm executed this strategy which is best described as a
a. Split-up
b. Split-off
c. Spin-off
d. Equity carveout
e. Reverse merger
8
20. The board of directors of a firm approves an exchange offer in which their shareholders are offered stock in one of the
firm’s subsidiaries in exchange for their holdings of parent company stock. This offer is best described as a
a. Split-up
b. Split-off
c. Equity carve-out
d. Spin-off
e. Tender offer
Case Study Short Essay Examination Questions
Motorola Bows to Activist Pressure
Under pressure from activist investor Carl Icahn, Motorola felt compelled to make a dramatic move before its May 2008
shareholders' meeting. Icahn had submitted a slate of four directors to replace those up for reelection and demanded that the
wireless handset and network manufacturer take actions to improve profitability. Shares of Motorola, which had a market value
of $22 billion, had fallen more than 60% since October 2006, making the firm’s board vulnerable in the proxy contest over
director reelections.
Signaling its willingness to take dramatic action, Motorola announced on March 26, 2008, its intention to create two
independent, publicly traded companies. The two new companies would consist of the firm's former Mobile Devices operation
(including its Home Devices businesses consisting of modems and set-top boxes) and its Enterprise Mobility Solutions &
Wireless Networks business. In addition to the planned spin-off, Motorola agreed to nominate two people supported by Carl
Icahn to the firm’s board. Originally scheduled for 2009, the breakup was postponed due to the upheaval in the financial
markets that year. The breakup would result in a tax-free distribution to Motorola's shareholders, with shareholders receiving
shares of the two independent and publicly traded firms.
The Mobile Devices business designs, manufactures, and sells mobile handsets globally, and it has lost more than $5
billion during the last three years. The Enterprise Mobility Solutions & Wireless Networks business manufactures, designs, and
services public safety radios, handheld scanners and telecommunications network gear for businesses and government agencies
and generates nearly all of the Motorola’s current cash flow. This business also makes network equipment for wireless carriers
such as Spring Nextel and Verizon Wireless.
By dividing the company in this manner, Motorola would separate its loss-generating Mobility Devices division from its
other businesses. Although the third largest handset manufacturer globally, the handset business had been losing market share
to Nokia and Samsung Electronics for years. Following the breakup, the Mobility Devices unit would be renamed Motorola
Mobility, and the Enterprise Mobility Solutions & Networks operation would be called Motorola Solutions.
Motorola’s board is seeking to ensure the financial viability of Motorola Mobility by eliminating its outstanding debt and
through a cash infusion. To do so, Motorola intends to buy back nearly all of its outstanding $3.9 billion debt and to transfer as
much as $4 billion in cash to Motorola Mobility. Furthermore, Motorola Solutions would assume responsibility for the pension
obligations of Motorola Mobility. If Motorola Mobility were to be forced into bankruptcy shortly after the breakup, Motorola
Solutions may be held legally responsible for some of the business’s liabilities. The court would have to prove that Motorola
had conveyed the Mobility Devices unit (renamed Motorola Mobility following the breakup) to its shareholders, fraudulently
knowing that the unit’s financial viability was problematic.
Once free of debt and other obligations and flush with cash, Motorola Mobility would be in a better position to make
acquisitions and to develop new phones. It would also be more attractive as a takeover target. A stand-alone firm is
unencumbered by intercompany relationships, including such things as administrative support or parts and services supplied by
other areas of Motorola. Moreover, all liabilities and assets associated with the handset business already would have been
identified, making it easier for a potential partner to value the business.
In mid-2010, Motorola Inc. announced that it had reached an agreement with Nokia Siemens Networks, a Finnish-German
joint venture, to buy the wireless networks operations, formerly part of its Enterprise Mobility Solutions & Wireless Network
Devices business for $1.2 billion. On January 4, 2011, Motorola Inc. spun off the common shares of Motorola Mobility it held
as a tax-free dividend to its shareholders and renamed the firm Motorola Solutions. Each shareholder of record as of December
21, 2010, would receive one share of Motorola Mobility common for every eight shares of Motorola Inc. common stock they
held. Table 15.3 shows the timeline of Motorola’s restructuring effort.
Discussion Questions
1. In your judgment, did the breakup of Motorola make sense? Explain your answer.
9
2. What other restructuring alternatives could Motorola have pursued to increase shareholder value? Why do you believe it
pursued this breakup strategy rather than some other option?
Table 15.3
Motorola Restructure Timeline
Motorola (Beginning 2010)
Motorola (Mid-2010)
Motorola (Beginning 2011)
Mobility Devices
Mobility Devices
Motorola Mobility spin-off
Enterprise Mobility Solutions &
Wireless Networks
Enterprise Mobility Solutions*
Motorola Inc. renamed Motorola
Solutions
*Wireless Networks sold to Nokia-Siemens.
Kraft Foods Undertakes Split-Off of Post Cereals in Merger-Related Transaction
In August 2008, Kraft Foods announced an exchange offer related to the split-off of its Post Cereals unit and the closing of the
merger of its Post Cereals business into a wholly-owned subsidiary of Ralcorp Holdings. Kraft is a major manufacturer and
distributor of foods and beverages; Post is a leading manufacturer of breakfast cereals; and Ralcorp manufactures and
distributes brand-name products in grocery and mass merchandise food outlets. The objective of the transaction was to allow
Kraft shareholders participating in the exchange offer for Kraft Sub stock to become shareholders in Ralcorp and Kraft to
receive almost $1 billion in cash or cash equivalents on a tax-free basis.
Prior to the transaction, Kraft borrowed $300 million from outside lenders and established Kraft Sub, a shell corporation
wholly owned by Kraft. Kraft subsequently transferred the Post assets and associated liabilities, along with the liability Kraft
incurred in raising $300 million, to Kraft Sub in exchange for all of Kraft Sub’s stock and $660 million in debt securities issued
by Kraft Sub to be paid to Kraft at the end of ten years. In effect, Post was conveyed to Kraft Sub in exchange for assuming
Kraft’s $300 million liability, 100% of Kraft Sub’s stock, and Kraft Sub debt securities with a principal amount of $660
million. The consideration that Kraft received, consisting of the debt assumption by Kraft Sub, the debt securities from Kraft
Sub, and the Kraft Sub stock, is considered tax free to Kraft, since it is viewed simply as an internal reorganization rather than
a sale.1 Kraft later converted to cash the securities received from Kraft Sub by selling them to a consortium of banks.
In the related split-off transaction, Kraft shareholders had the option to exchange their shares of Kraft common stock for
shares of Kraft Sub, which owned the assets and liabilities of Post. If Kraft was unable to exchange all of the Kraft Sub
common shares, Kraft would distribute the remaining shares as a dividend (i.e., spin-off) on a pro rata basis to Kraft
shareholders.
With the completion of the merger of Kraft Sub with Ralcorp Sub (a Ralcorp wholly-owned subsidiary), the common shares
of Kraft Sub were exchanged for shares of Ralcorp stock on a one for one basis. Consequently, Kraft shareholders tendering
their Kraft shares in the exchange offer owned 0.6606 of a share of Ralcorp stock for each Kraft share exchanged as part of the
split-off.
Concurrent with the exchange offer, Kraft closed the merger of Post with Ralcorp. Kraft shareholders received Ralcorp
stock valued at $1.6 billion, resulting in their owning 54% of the merged firm. By satisfying the Morris Trust tax code
regulations,2 the transaction was tax free to Kraft shareholders. Ralcorp Sub was later merged into Ralcorp. As such, Ralcorp
assumed the liabilities of Ralcorp Sub, including the $660 million owed to Kraft.
The purchase price for Post equaled $2.56 billion. This price consisted of $1.6 billion in Ralcorp stock received by Kraft
shareholders and $960 million in cash equivalents received by Kraft. The $960 million included the assumption of the $300
million liability by Kraft Sub and the $660 million in debt securities received from Kraft Sub.3 The steps involved in the
transaction are described in Exhibit 15.1.
Discussion Questions and Answers:
1. What does the decision to split up the firm say about Kraft’s decision to buy Cadbury in 2010?
1 The intracompany transfer of certain assets and associated liabilities is considered a tax-free event if it complies with the requirements of a D reorganization under Section 355 of the U.S.
Internal Revenue Code.
2 Split-offs and spin-offs undertaken as part of a merger must be structured to satisfy Morris Trust tax code rules if they are to be tax free. Such rules require that the shareholders of the parent
undertaking the split-off or spin-off end up as majority shareholders in the merged firm.
3 The $660 million represents the book value of the debt on the merger closing date. The more correct representation in calculating the purchase price would be to estimate its market value.
2. Why did Kraft chose not to divest its grocery business, using the proceeds to either reinvest in its faster growing snack
business, to buy back its stock, or a combination of the two?
3. How might a spin-off create shareholder value for Kraft Foods shareholders?
4. Kraft CEO Irene Rosenfeld argued that an important justification for the Cadbury acquisition in 2010 was to create
two portfolios of businesses: some very strong cash generating businesses and some very strong growth businesses in
order to increase shareholder value. How might this strategy have boosted the firm’s value?
5. While Kraft’s share value did increase following the Cadbury deal, it lagged the performance of key competitors. Why
do you believe this was the case? Explain your answer.
6. There is often a natural tension between so-called activist investors interested in short-term profits and a firm’s
management interested in pursuing a longer-term vision. When is this tension helpful to shareholders and when does it
destroy shareholder value?
11
Exhibit 15-1. Structuring the Transaction
Step 1: Kraft creates a shell subsidiary (Kraft Sub) and transfers Post assets and liabilities and
$300 million in Kraft debt into the shell in exchange for Kraft Sub stock plus $660 million in
Kraft Sub debt securities. Kraft also implements an exchange offer of Kraft Sub for Kraft
common stock.
Step 2: Kraft Sub, as an independent company, is merged in a forward triangular tax-free merger with a sub of Ralcorp
(Ralcorp Sub) in which Kraft Sub shares are exchanged for Ralcorp shares, with Ralcorp Sub surviving.4
Sara Lee Attempts to Create Value through Restructuring
4 The merger is tax free to Kraft Sub shareholders in that it results in Kraft Sub shareholders owning a significant ongoing
interest in Ralcorp and Ralcorp owing the Kraft Sub assets. Consequently, both the continuity of interests and the continuity of
business enterprise principles are satisfied. See Chapter 12 for a more detailed discussion of these issues.
Kraft Sub (Post)
Kraft Shareholders
Tendering Kraft Shares
Kraft Foods
Post Assets &
Liabilities +
Assumed $300
Million in Kraft
Debt
Kraft Sub
Common Shares +
$660 Million in
Kraft Sub Debt
Securities
Kraft Shares
Kraft Sub Shares
Ralcorp
Ralcorp Sub
Kraft Sub (Post)
Kraft Sub Shareholders
(i.e., former Kraft
Shareholders)
Ralcorp
Stock
Ralcorp
Sub Stock
Kraft Sub Assets & Liabilities
Ralcorp
Stock
Kraft Sub
Stock
12
After spurning a series of takeover offers, Sara Lee, a global consumer goods company, announced in early 2011 its intention
to split the firm into two separate publicly traded companies. The two companies would consist of the firm’s North American
retail and food service division and its international beverage business. The announcement comes after a long string of
restructuring efforts designed to increase shareholder value. It remains to be seen if the latest effort will be any more successful
than earlier efforts.
Reflecting a flawed business strategy, Sara Lee had struggled for more than a decade to create value for its shareholders by
radically restructuring its portfolio of businesses. The firm’s business strategy had evolved from one designed in the mid-1980s
to market a broad array of consumer products from baked goods to coffee to underwear under the highly recognizable brand
name of Sara Lee into one that was designed to refocus the firm on the faster-growing food and beverage and apparel
businesses. Despite acquiring several European manufacturers of processed meats in the early 1990s, the company’s profits and
share price continued to flounder.
In September 1997, Sara Lee embarked on a major restructuring effort designed to boost both profits, which had been
growing by about 6% during the previous five years, and the company’s lagging share price. The restructuring program was
intended to reduce the firm’s degree of vertical integration, shifting from a manufacturing and sales orientation to one focused
on marketing the firm’s top brands. The firm increasingly viewed itself as more of a marketing than a manufacturing
enterprise.
Sara Lee outsourced or sold 110 manufacturing and distribution facilities over the next two years. Nearly 10,000 employees,
representing 7% of the workforce, were laid off. The proceeds from the sale of facilities and the cost savings from outsourcing
were either reinvested in the firm’s core food businesses or used to repurchase $3 billion in company stock. 1n 1999 and 2000,
the firm acquired several brands in an effort to bolster its core coffee operations, including such names as Chock Full o’Nuts,
Hills Bros, and Chase & Sanborn.
Despite these restructuring efforts, the firm’s stock price continued to drift lower. In an attempt to reverse the firm’s
misfortunes, the firm announced an even more ambitious restructuring plan in 2000. Sara Lee would focus on three main areas:
food and beverages, underwear, and household products. The restructuring efforts resulted in the shutdown of a number of
meat packing plants and a number of small divestitures, resulting in a 10% reduction (about 13,000 people) in the firm’s
workforce. Sara Lee also completed the largest acquisition in its history, purchasing The Earthgrains Company for $1.9 billion
plus the assumption of $0.9 billion in debt. With annual revenue of $2.6 billion, Earthgrains specialized in fresh packaged
bread and refrigerated dough. However, despite ongoing restructuring activities, Sara Lee continued to underperform the
broader stock market indices.
In February 2005, Sara Lee executed its most ambitious plan to transform the firm into a company focused on the global
food, beverage, and household and body care businesses. To this end, the firm announced plans to dispose of 40% of its
revenues, totaling more than $8 billion, including its apparel, European packaged meats, U.S. retail coffee, and direct sales
businesses.
In 2006, the firm announced that it had completed the sale of its branded apparel business in Europe, Global Body Care and
European Detergents units, and its European meat processing operations. Furthermore, the firm spun off its U.S. Branded
Apparel unit into a separate publicly traded firm called HanesBrands Inc. The firm raised more than $3.7 billion in cash from
the divestitures. The firm was now focused on its core businesses: food, beverages, and household and body care.
In late 2008, Sara Lee announced that it would close its kosher meat processing business and sold its retail coffee business.
In 2009, the firm sold its Household and Body Care business to Unilever for $1.6 billion and its hair care business to Procter &
Gamble for $0.4 billion.
In 2010, the proceeds of the divestitures made the prior year were used to repurchase $1.3 billion of Sara Lee’s outstanding
shares. The firm also announced its intention to repurchase another $3 billion of its shares during the next three years. If
completed, this would amount to about one-third of its approximate $10 billion market capitalization at the end of 2010.
What remains of the firm are food brands in North America, including Hillshire Farm, Ball Park, and Jimmy Dean
processed meats and Sara Lee baked goods and Earthgrains. A food distribution unit will also remain in North America, as will
its beverage and bakery operations. Sara Lee is rapidly moving to become a food, beverage, and bakery firm. As it becomes
more focused, it could become a takeover target.
Has the 2005 restructuring program worked? To answer this question, it is necessary to determine the percentage change in
Sara Lee’s share price from the announcement date of the restructuring program to the end of 2010, as well as the percentage
change in the share price of HanesBrands Inc., which was spun off on August 18, 2006. Sara Lee shareholders of record
received one share of HanesBrands Inc. for every eight Sara Lee shares they held.
Sara Lee’s share price jumped by 6% on the February 21, 2004 announcement date, closing at $19.56. Six years later, the
stock price ended 2010 at $14.90, an approximate 24% decline since the announcement of the restructuring program in early
2005. Immediately following the spinoff, HanesBrands’ stock traded at $22.06 per share; at the end of 2010, the stock traded at
$25.99, a 17.8% increase.
A shareholder owning 100 Sara Lee shares when the spin-off was announced would have been entitled to 12.5 HanesBrands
shares. However, they would have actually received 12 shares plus $11.03 for fractional shares (i.e., 0.5 × $22.06).
A shareholder of record who had 100 Sara Lee shares on the announcement date of the restructuring program and held their
shares until the end of 2010 would have seen their investment decline 24% from $1,956 (100 shares × $19.56 per share) to
$1,486.56 by the end of 2010. However, this would have been partially offset by the appreciation of the HanesBrands shares
between 2006 and 2010. Therefore, the total value of the hypothetical shareholder’s investment would have decreased by 7.5%
from $1,956 to $1,809.47 (i.e., $1,486.56 + 12 HanesBrands shares × $25.99 + $11.03). This compares to a more modest 5%
loss for investors who put the same $1,956 into a Standard & Poor’s 500 stock index fund during the same period.
Why did Sara Lee underperform the broader stock market indices during this period? Despite the cumulative buyback of
more than $4 billion of its outstanding stock, Sara Lee’s fully diluted earnings per share dropped from $0.90 per share in 2005
to $0.52 per share in 2009. Furthermore, the book value per share, a proxy for the breakup or liquidation value of the firm,
dropped from $3.28 in 2005 to $2.93 in 2009, reflecting the ongoing divestiture program. While the HanesBrands spin-off did
create value for the shareholder, the amount was far too modest to offset the decline in Sara Lee’s market value. During the
same period, total revenue grew at a tepid average annual rate of about 3% to about $13 billion in 2009.
Case Study Discussion Questions:
1. In what sense is the Sara Lee business strategy in effect a breakup strategy? Be specific.
2. Would you expect investors to be better off buying Sara Lee stock or investing in a similar set of consumer
product businesses in their own personal investment portfolios? Explain your answer.
3. Speculate as to why the 2005 restructure program appears to have been unsuccessful in achieving a sustained
increase in Sara Lee’s earnings per share and in turn creating value for the Sara Lee shareholders?
4. Why is a breakup strategy conceptually simple to explain but often difficult to implement? Be specific.
