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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.
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5. Explain why Sara Lee may have chosen to spin-off rather than to divest HanesBrands Inc.? Be specific.
Bristol-Myers Squibb Splits Off Rest of Mead Johnson
Facing the loss of patent protection for its blockbuster drug Plavix, a blood thinner, in 2012, Bristol-Myers Squibb Company
decided to split off its 83% ownership stake in Mead Johnson Nutrition Company in late 2009 through an offer to its
shareholders to exchange their Bristol-Myers shares for Mead Johnson shares. The decision was part of a longer-term
restructuring strategy that included the sale of assets to raise money for acquisitions of biotechnology drug companies and the
elimination of jobs to reduce annual operating expenses by $2.5 billion by the end of 2012.
Bristol-Myers anticipated a significant decline in operating profit following the loss of patent protection as increased
competition from lower-priced generics would force sizeable reductions in the price of Plavix. Furthermore, Bristol-Myers
considered Mead Johnson, a baby formula manufacturer, as a noncore business that was pursuing a focus on biotechnology
drugs. Bristol-Myers shareholders greeted the announcement positively, with the firm’s shares showing the largest one-day
increase in eight months.
In the exchange offer, Bristol-Myers shareholders were able to exchange some, none, or all of their shares of Bristol-Myers
common stock for shares of Mead Johnson common stock at a discount. The discount was intended to provide an incentive for
Bristol-Myers shareholders to tender their shares. Also, the rapid appreciation of the Mead Johnson shares in the months
leading up to the announced split-off suggested that these shares could have attractive long-term appreciation potential.
The exchange was tax free to Bristol-Myers shareholders participating in the exchange offer, who also stood to gain if the
now independent Mead Johnson Corporation were acquired at a later date. The newly independent Mead Johnson had a poison
pill in place to discourage any takeover within six months to a year following the split-off. The tax-free status of the transaction
could have been disallowed by the IRS if the transaction were viewed as a “disguised sale” intended to allow Bristol-Myers to
avoid paying taxes on gains incurred if it had chosen to sell Mead Johnson.
British Petroleum Sells Oil and Gas Assets to Apache Corporation
In the months that followed the oil spill in the Gulf of Mexico, British Petroleum agreed to create a $20 billion fund to help
cover the damages and cleanup costs associated with the spill. The firm had agreed to contribute $5 billion to the fund before
the end of 2010. To help meet this obligation and to help finance the more than $4 billion already spent on the spill, the firm
announced on July 20, 2010, that it had reached an agreement to sell Apache Corporation its oil and gas fields in Texas and
southeast New Mexico worth $3.1 billion; gas fields in Western Canada for $3.25 billion; and oil and gas properties in Egypt
for $650 million. All of these properties had been in production for years, and their output rates were declining.
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Apache is a Houston, Texas–based independent oil and gas exploration firm with a reputation for being able to extract
additional oil and gas from older properties. Also, Apache had operations near each of the BP properties, enabling them to take
control of the acquired assets with existing personnel.
In what appears to have been a premature move, Apache agreed to acquire Mariner Energy and Devon Energy’s offshore
assets in the Gulf of Mexico for a total of $3.75 billion just days before the BP oil rig explosion in the Gulf. The acquisitions
made Apache a major player in the Gulf just weeks before the United States banned temporarily deep-water drilling
exploration in federal waters.
The announcement of the sale of these properties came as a surprise because BP had been rumored to be attempting to sell
its stake in the oil fields of Prudhoe Bay, Alaska. The sale had been expected to fetch as much as $10 billion. The sale failed to
materialize because of lingering concerns that BP might at some point seek bankruptcy protection and because the firm’s
creditors could seek to reverse an out-of-court asset sale as a fraudulent conveyance of assets. Fraudulent conveyance refers to
the illegal transfer of assets to another party in order to defer, hinder, or defraud creditors. Under U.S. bankruptcy laws, courts
might order that any asset sold by a company in distress, such as BP, must be encumbered with some of the liabilities of the
seller if it can be shown that the distressed firm undertook the sale with the full knowledge that it would be filing for
bankruptcy protection at a later date.
Ideally, buyers would like to purchase assets “free and clear” of the environmental liabilities associated with the Gulf oil
spill. Consequently, a buyer of BP assets would have to incorporate such risks in determining the purchase price for such
assets. In some instances, buyers will buy assets only after the seller has gone through the bankruptcy process in order to limit
fraudulent conveyance risks.
Discussion Questions
1. In what sense were the BP properties strategically more valuable to Apache than to British Petroleum?
2. How could Apache have protected itself from risks that they might be required at some point in the future to be liable
for some portion of the BP Gulf–related liabilities? What are some of the ways Apache could have estimated the
potential costs of such liabilities? Be specific.
Anatomy of a Spin-Off
On October 18, 2006, Verizon Communication's board of directors declared a dividend to the firm's shareholders consisting of
shares in a company comprising the firm's domestic print and Internet yellow pages directories publishing operations (Idearc
Inc.). The dividend consisted of 1 share of Idearc stock for every 20 shares of Verizon common stock. Idearc shares were
valued at $34.47 per share. On the dividend payment date, Verizon shares were valued at $36.42 per share. The 1-to-20 ratio
constituted a 4.73% yield—that is, $34.47/ ($36.42 × 20)—approximately equal to Verizon's then current cash dividend yield.
Because of the spin-off, Verizon would contribute to Idearc all its ownership interest in Idearc Information Services and
other assets, liabilities, businesses, and employees currently employed in these operations. In exchange for the contribution,
Idearc would issue to Verizon shares of Idearc common stock to be distributed to Verizon shareholders. In addition, Idearc
would issue senior unsecured notes to Verizon in an amount approximately equal to the $9 billion in debt that Verizon incurred
in financing Idearc's operations historically. Idearc would also transfer $2.5 billion in excess cash to Verizon. Verizon believed
it owned such cash balances, since they were generated while Idearc was part of the parent.
In late 2009, Idearc entered Chapter 11 bankruptcy because it was unable to meet its outstanding debt obligations. In
September 2010, a trustee for Idearc’s creditors filed a lawsuit against Verizon, alleging that the firm breached its fiduciary
responsibility by knowingly spinning off a business that was not financially viable. The lawsuit further contends that Verizon
benefitted from the spin-off at the expense of the creditors by transferring $9 billion in debt from its books to Idearc and
receiving $2.5 billion in cash from Idearc.
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Discussion Questions
1. How do you believe the Idearc shares were valued for purposes of the spin-off? Be specific.
2. Do you believe that it is fair for Idearc to repay a portion of the debt incurred by Verizon relating to Idearc's operations even
though Verizon included Idearc's earnings in its consolidated income statement? Is the transfer of excess cash to the parent
fair? Explain your answer.
3. Do you believe shareholders should have the right to approve a spin-off? Explain your answer?
4. To what extent do you believe that Verizon’s activities could be viewed as fraudulent? Explain your answer.
Anatomy of a Split-Off: Bristol-Myers Squibb
Under the Bristol-Myers Squibb exchange offer of Mead Johnson shares for shares of its common stock, announced on
November 16, 2009, each BMS shareholder would receive $1.11 for each $1 of BMS stock tendered and accepted in the
exchange offer. The exchange was subject to an upper limit of 0.6027 shares of MJ common stock per share of BMS common.
On December 4, 2009, BMS amended the offer by increasing the maximum share exchange ratio to 0.6313, indicating it
would accept for exchange a maximum of 269,281,601 shares of its stock and that if the exchange offer were oversubscribed,
all shares tendered would be subject to proration. The proration formula was be determined by dividing the maximum number
of MJ shares BMS was willing to exchange by the number of BMS shares actually tendered.
0.6313 × $43.75). Therefore, a BMS shareholder tendering 100 shares of BMS stock would have received the share equivalent
of $2,762 ($27.62 × 100) or 63.13 MJ shares at $43.75 per shares (i.e., $2,762 ÷ $43.75). Fractional shares were paid in cash.
The actual number of BMS shares tendered totaled 500,547,697, resulting in a proration ratio of 53.80% (i.e., 269,281,601 ÷
500,547,697). Each shareholder tendering BMS shares would only have 53.80% of their tendered shares accepted for the
exchange.
Discussion Questions:
1. Why did Bristol-Myers Squibb offer its shareholders $1.11 worth of Mead Johnson stock for each $1 of Bristol-Myers
Squibb stock tendered and accepted in the exchange offer?
2. Why did Bristol-Myers Squibb prorate the number of shares tendered in the exchange offer?
Inside M&A. Financial Services Firms Streamline their Operations
During 2005 and 2006, a wave of big financial services firms announced their intentions to spin-off operations that did
not seem to fit strategically with their core business. In addition to realigning their strategies, the parent firms noted the
favorable tax consequences of a spin-off, the potential improvement in the parent's financial returns, the elimination of
conflicts with customers, and the removal of what, for some, had become a management distraction.
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Investment bank Morgan Stanley announced in mid-2005 its intent to spin-off its Discover Credit Card operation.
While Discover Card generated about one fifth of the firm's pretax profits, Morgan Stanley had been unable to realize
significant synergies with its other operations. The move represented an attempt by senior Morgan Stanley management to
mute shareholder criticism of the company's lackluster stock performance due to what many viewed had been the firm's
excessive diversification.
Similarly, J.P. Morgan Chase announced plans in 2006 to spin off its $13 billion private equity fund, J.P. Morgan
Partners. The bank would invest up to $1 billion in a new fund J.P. Morgan Partners plans to open as a successor to the current
Global Fund. Because the bank's ownership position would be less than 25 percent, it would be classified as a passive partner.
The expectation is that, by jettisoning this operation, the bank would be able to reduce earnings volatility and decrease
competition between the bank and large customers when making investments.
Discussion Questions:
1. Speculate as to why a firm may choose to spin-off rather than divest a business?
2. In what ways might the spin-offs harm parent firm shareholders?
AT&T (1984 – 2005)—A POSTER CHILD
FOR RESTRUCTURING GONE AWRY
Between 1984 and 2000, AT&T underwent four major restructuring programs. These included the government-mandated
breakup in 1984, the 1996 effort to eliminate customer conflicts, the 1998 plan to become a broadband powerhouse, and the
most recent restructuring program announced in 2000 to correct past mistakes. It is difficult to identify another major
corporation that has undergone as much sustained trauma as AT&T. Ironically, a former AT&T operating unit acquired its
former parent in 2005.
The 1984 Restructure: Changed the Organization But Not the Culture
The genesis of Ma Bell’s problems may have begun with the consent decree signed with the Department of Justice in 1984,
which resulted in the spin-off of its local telephone operations to its shareholders. AT&T retained its long-distance and
telecommunications equipment manufacturing operations. Although the breadth of the firm’s product offering changed
dramatically, little else seems to have changed. The firm remained highly bureaucratic, risk averse, and inward looking.
However, substantial market share in the lucrative long-distance market continued to generate huge cash flow for the company,
thereby enabling the company to be slow to react to the changing competitive dynamics of the marketplace.
The 1996 Restructure: Lack of a Coherent Strategy
The 1998 Restructure: Vision Exceeds Ability to Execute
In its third major restructure since 1984, AT&T CEO Michael Armstrong passionately unveiled in June of 1998 a daring
strategy to transform AT&T from a struggling long-distance telephone company into a broadband internet access and local
40
phone services company. To accomplish this end, he outlined his intentions to acquire cable companies MediaOne Group and
Telecommunications Inc. for $58 billion and $48 billion, respectively. The plan was to use cable-TV networks to deliver the
first fully integrated package of broadband internet access and local phone service via the cable-TV network.
AT&T Could Not Handle Its Early Success
During the next several years, Armstrong seemed to be up to the task, cutting sales, general, and administrative expense’s
share of revenue from 28 percent to 20 percent, giving AT&T a cost structure comparable to its competitors. He attempted to
change the bureaucratic culture to one able to compete effectively in the deregulated environment of the post-1996
Telecommunications Act by issuing stock options to all employees, tying compensation to performance, and reducing layers of
managers. He used AT&T’s stock, as well as cash, to buy the cable companies before the decline in AT&T’s long-distance
business pushed the stock into a free fall. He also transformed AT&T Wireless from a collection of local businesses into a
national business.
Notwithstanding these achievements, AT&T experienced major missteps. Employee turnover became a big problem,
especially among senior managers. Armstrong also bought Telecommunications and MediaOne when valuations for cable-
television assets were near their peak. He paid about $106 billion in 2000, when they were worth about $80 billion. His failure
to cut enough deals with other cable operators (e.g., Time Warner) to sell AT&T’s local phone service meant that AT&T could
market its services only in regional markets rather than on a national basis. In addition, AT&T moved large corporate
customers to its Concert joint venture with British Telecom, alienating many AT&T salespeople, who subsequently quit. As a
result, customer service deteriorated rapidly and major customers defected. Finally, Armstrong seriously underestimated the
pace of erosion in AT&T’s long-distance revenue base.
AT&T May Have Become Overwhelmed by the Rate of Change
What happened? Perhaps AT&T fell victim to the same problems many other acquisitive companies have. AT&T is a company
capable of exceptional vision but incapable of effective execution. Effective execution involves buying or building assets at a
reasonable cost. Its substantial overpayment for its cable acquisitions meant that it would be unable to earn the returns required
by investors in what they would consider a reasonable period. Moreover, Armstrong’s efforts to shift from the firm’s historical
business by buying into the cable-TV business through acquisition had saddled the firm with $62 billion in debt.
Furthermore, AT&T created individual tracking stocks for AT&T Wireless and for Liberty Media. The intention of the
tracking stocks was to link the unit’s stock to its individual performance, create a currency for the unit to make acquisitions,
and to provide a new means of motivating the unit’s management by giving them stock in their own operation. Unlike a spin-
off, AT&T’s board continued to exert direct control over these units. In an IPO in April 2000, AT&T sold 14 percent of
AT&T’s Wireless tracking stock to the public to raise funds and to focus investor attention on the true value of the Wireless
operations.
Investors Lose Patience
Although all of these actions created a sense that grandiose change was imminent, investor patience was wearing thin.
Profitability foundered. The market share loss in its long-distance business accelerated. Although cash flow remained strong, it
was clear that a cash machine so dependent on the deteriorating long-distance telephone business soon could grind to a halt.
Investors’ loss of faith was manifested in the sharp decline in AT&T stock that occurred in 2000.
The 2000 Restructure: Correcting the Mistakes of the Past
Pushed by investor impatience and a growing realization that achieving AT&T’s vision would be more time and resource
consuming than originally believed, Armstrong announced on October 25, 2000 the breakup of the business for the fourth time.
The plan involved the creation of four new independent companies including AT&T Wireless, AT&T Consumer, AT&T
Broadband, and Liberty Media.
By breaking the company into specific segments, AT&T believed that individual units could operate more efficiently and
aggressively. AT&T’s consumer long-distance business would be able to enter the digital subscriber line (DSL) market. DSL is
a broadband technology based on the telephone wires that connect individual homes with the telephone network. AT&T’s
cable operations could continue to sell their own fast internet connections and compete directly against AT&T’s long-distance
telephone business. Moreover, the four individual businesses would create “pure-play” investor opportunities. Specifically,
AT&T proposed splitting off in early 2001 AT&T Wireless and issuing tracking stocks to the public in late 2001 for AT&T’s
Consumer operations, including long-distance and Worldnet Internet service, and AT&T’s Broadband (cable) operations. The
tracking shares would later be converted to regular AT&T common shares as if issued by AT&T Broadband, making it an
independent entity. AT&T would retain AT&T Business Services (i.e., AT&T Lab and Telecommunications Network) with
the surviving AT&T entity. Investor reaction was swift and negative. Not swayed by the proposal, investors caused the stock
to drop 13 percent in a single day. Moreover, it ended 2000 at 17 ½, down 66 percent from the beginning of the year.
The More Things Change The More They Stay The Same
After extended discussions, AT&T agreed on December 21, 2001 to merge its broadband unit with Comcast to create the
largest cable television and high-speed internet service company in the United States. Without the future growth engine offered
by Broadband and Wireless, AT&T’s remaining long-distance businesses and business services operations had limited growth
prospects. After a decade of tumultuous change, AT&T was back where it was at the beginning of the 1990s. At about $15
billion in late 2004, AT&T’s market capitalization was about one-sixth of that of such major competitors as Verizon and SBC.
SBC Communications (a former local AT&T operating company) acquired AT&T on November 18, 2005 in a $16 billion deal
and promptly renamed the combined firms AT&T.
1. What were the primary factors contributing to AT&T’s numerous restructuring efforts since 1984? How did they
differ? How were they similar?
2. Why do you believe that AT&T chose to split-off its wireless operations rather than to divest the unit? What might
you have done differently?
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3. Was AT&T proactive or reactive in initiating its 2000 restructuring program? Explain your answer.
4. AT&T overpaid for many of its largest acquisitions made during the 1990s? How might this have contributed to its
subsequent restructuring efforts?
5. To what extent did AT&T’s ineffectual restructuring reflect factors beyond their control and to what extent was it
poor implementation?
6. What challenges did AT&T face in trying to split-up the company in 2000? What might you have done differently to
overcome these obstacles?
Viacom to Spin Off Blockbuster
After months of trying to sell its 81% stake in Blockbuster Inc. undertook a tax-free spin-off in mid 2004. Viacom shareholders
will have the option to swap their Viacom shares for Blockbuster shares and a special cash payout. Blockbuster had been hurt
by competition from low-priced rivals and the erosion of video rentals by accelerating DVD sales. Despite Blockbuster’s
steady contribution to Viacom’s overall cash flow, Viacom believed that the growth prospects for the unit were severely
43
limited. In preparation for the spin-off, Viacom had reported a $1.3 billion charge to earnings in the fourth quarter of 2003 in
writing down goodwill associated with its acquisition of Blockbuster. By spinning off Blockbuster, Viacom Chairman and
ECO Sumner Redstone statd that the firm would now be able to focus on its core TV (i.e., CBS and MTV) and movie (i.e.,
Paramount Studios) businesses. Blockbuster shares fell by 4% and Viacom shares rose by 1% on the day of the announcement.
Discussion Questions:
1. Why would Viacom choose to spin-off rather than divest its Blockbuster unit? Explain your answer.
2. In your opinion, why did Viacom and Blockbuster share prices react the way they did to the announcement of the
spin-off?
Baxter to Spin Off Heart Care Unit
Baxter International Inc. announced in late 1999 its intention to spin off its underperforming cardiovascular business, creating a
new company that will specialize in treatments for heart disease. The new company will have 6000 employees worldwide and
annual revenue in excess of $1 billion. The unit sells biological heart valves harvested from pigs and cows, catheters and other
products used to monitor hearts during surgery, and heart-assist devices for patients awaiting surgery. Baxter conceded that
they have been ‘‘optimizing’’ the cardiovascular business by not making the necessary investments to grow the business. In
contrast, the unit’s primary competitors, Guidant, Medtronic, and Boston Scientific, are spending more on research and
investing more on start-up companies that are developing new technologies than is Baxter.
With the spin-off, the new company will have the financial resources that formerly had been siphoned off by the parent, to
create an environment that will more directly encourage the speed and innovation necessary to compete effectively in this
industry. The unit’s stock will be used to provide additional incentive for key employees and to serve as a means of making
future acquisitions of companies necessary to extend the unit’s product offering.
Discussion Questions
1. In your judgment, what did Baxter’s management mean when they admitted that they had not been “optimizing” the
cardiovascular business in recent years? Explain both the strategic and financial implications of this strategy.
2. Discuss some of the reasons why you believe the unit may prosper more as an independent operation than as part of
Baxter?
Gillette Announces Divestiture Plans
44
With 1998 sales of $10.1 billion, Gillette is the world leader in the production of razor blades, razors, and shaving cream.
Gillette also has a leading position in the production of pens and other writing instruments. Gillette’s consolidated operating
performance during 1999 depended on its core razor blade and razor, Duracell battery, and oral care businesses. Reflecting
disappointment in the performance of certain operating units, Gillette’s CEO, Michael Hawley, announced in October 1999 his
intention to divest poorly performing businesses unless he could be convinced by early 2000 that they could be turned around.
The businesses under consideration at that time comprised about 15% of the company’s $10 billion in annual sales. Hawley
saw the new focus of the company to be in razor blades, batteries, and oral care. To achieve this new focus, Hawley intended to
prune the firm’s product portfolio. The most likely targets for divestiture at the time included pens (i.e., PaperMate, Parker, and
Waterman), with the prospects for operating performance for these units considered dismal. Other units under consideration for
divestiture included Braun and toiletries. With respect to these businesses, Hawley apparently intended to be selective. At
Braun, where overall operating profits plunged 43% in the first three quarters of 1999, Hawley has announced that Gillette will
keep electric shavers and electric toothbrushes. However, the household and personal care appliance units are likely divestiture
candidates. The timing of these sales may be poor. A decision to sell Braun at this time would compete against Black &
Decker’s recently announced decision to sell its appliance business.
Although Gillette would be smaller, the firm believes that its margins will improve and that its earnings growth will be more
rapid. Moreover, divesting such problem businesses as pens and appliances would let management focus on the units whose
prospects are the brightest. These are businesses that Gillette’s previous management was simply not willing to sell because of
their perceived high potential.
Discussion Questions:
1. Which of the major restructuring motives discussed in this chapter seem to be a work in this business case? Explain
your answer.
1. Describe the process Gillette’s management may have gone through to determine which business units to sell and
which to keep.
2. Comment on the timing of the sale.
United Parcel Service Goes Public in an Equity IPO
On November 10, 1999, United Parcel Service (UPS) raised $5.47 billion by selling 109.4 million shares of Class B common
stock at an offering price of $50 per share in the biggest IPO by any U.S. firm in history. The share price exploded to $67.38 at
the end of the first day of trading. The IPO represented 9% of the firm’s stock and established the firm’s total market value at
$81.9 billion (i.e., [$67.38 x 109.4 / .09]). With 1998 revenue of $24.8 billion, UPS transports more than 3 billion parcels and
documents annually. The company provides services in more than 200 countries.
By issuing only a portion of its Class B stock to the public, UPS was interested in ensuring that control would remain in the
hands of current management. The cash proceeds of the stock issue were used to buy back about 9% of the Class A voting
stock held by employees and by heirs to the founding Casey family, thereby keeping the total number of shares outstanding
constant. The Class B shares have one vote each, whereas the Class A shares have 10 votes. In addition, the issuance of Class
B stock provides a currency for making acquisitions. UPS had attempted unsuccessfully to acquire certain firms that had
indicated a strong desire for UPS shares rather than cash.
The beneficiaries of the sale include UPS employees from top management to workers on the loading docks. In a growing
trend in U.S. companies to generate greater employee loyalty and productivity, UPS offered all 330,000 employees worldwide
45
an opportunity to buy shares in this highly profitable company at prices as low as $20 per share. Before UPS, the largest IPOs
included Conoco in October 1998 at $4.40 billion, Goldman Sachs in May 1999 at $3.66 billion, Charter Communications in
November 1999 at $3.23 billion, and Lucent Technologies in April 1996 at $3 billion.
Discussion Questions:
1. Describe the motivation for UPS to undertake this type of transaction.
Hewlett Packard Spins Out Its Agilent Unit in a Staged Transaction
Hewlett Packard (HP) announced the spin-off of its Agilent Technologies unit to focus on its main business of computers and
printers, where sales have been lagging behind such competitors as Sun Microsystems. Agilent makes test, measurement, and
monitoring instruments; semiconductors; and optical components. It also supplies patient-monitoring and ultrasound-imaging
equipment to the health care industry. HP will retain an 85% stake in the company. The cash raised through the 15% equity
carve-out will be paid to HP as a dividend from the subsidiary to the parent. Hewlett Packard will provide Agilent with $983
million in start-up funding. HP retained a controlling interest until mid-2000, when it spun-off the rest of its shares in Agilent
to HP shareholders as a tax-free transaction.
Case Study Discussion Questions
1. Discuss the reasons why HP may have chosen a staged transaction rather than an outright divestiture of the business.
2. Discuss the conditions under which this spin-off would constitute a tax-free transaction.
USX Bows to Shareholder Pressure to Split Up the Company
As one of the first firms to issue tracking stocks in the mid-1980s, USX relented to ongoing shareholder pressure to divide the
firm into two pieces. After experiencing a sharp “boom/bust” cycle throughout the 1970s, U.S. Steel had acquired Marathon
Oil, a profitable oil and gas company, in 1982 in what was at the time the second largest merger in U.S. history. Marathon had
shown steady growth in sales and earnings throughout the 1970s. USX Corp. was formed in 1986 as the holding company for
both U.S. Steel and Marathon Oil. In 1991, USX issued its tracking stocks to create “pure plays” in its primary businesses—
steel and oil—and to utilize USX’s steel losses, which could be used to reduce Marathon’s taxable income. Marathon
shareholders have long complained that Marathon’s stock was selling at a discount to its peers because of its association with
USX. The campaign to split Marathon from U.S. Steel began in earnest in early 2000.
On April 25, 2001, USX announced its intention to split U.S. Steel and Marathon Oil into two separately traded companies.
The breakup gives holders of Marathon Oil stock an opportunity to participate in the ongoing consolidation within the global
oil and gas industry. Holders of USX–U.S. Steel Group common stock (target stock) would become holders of newly formed
Pittsburgh-based United States Steel Corporation, a return to the original name of the firm formed in 1901. Under the
reorganization plan, U.S. Steel and Marathon would retain the same assets and liabilities already associated with each business.
However, Marathon will assume $900 million in debt from U.S. Steel, leaving the steelmaker with $1.3 billion of debt. This
46
assumption of debt by Marathon is an attempt to make U.S. Steel, which continued to lose money until 2004, able to stand on
its own financially.
The investor community expressed mixed reactions, believing that Marathon would be likely to benefit from a possible
takeover attempt, whereas U.S. Steel would not fare as well. Despite the initial investor pessimism, investors in both Marathon
and U.S. Steel saw their shares appreciate significantly in the years immediately following the breakup.
:
Discussion Questions:
1. Why do you believe U.S. Steel may have decided to acquire Marathon Oil? Does this combination make economic
sense? Explain your answer.
2. Why do you think USX issued separate tracking stocks for its oil and steel businesses?
3. Why do you believe USX shareholders were not content to continue to hold tracking stocks in Marathon Oil and U.S.
Steel?
4. In your judgment, did the breakup of USX into Marathon Oil and United States Steel
Corporation make sense? Why or why not?
5. What other alternatives could USX have pursued to increase shareholder value? Why do you believe they pursued the
breakup strategy rather than some of the alternatives?
Hughes Corporation's Dramatic Transformation
In one of the most dramatic redirections of corporate strategy in U.S. history, Hughes Corporation transformed itself from a
defense industry behemoth into the world's largest digital information and communications company. Once California's largest
manufacturing employer, Hughes Corporation built spacecraft, the world's first working laser, communications satellites, radar
systems, and military weapons systems. However, by the late 1990s, the firm had undergone substantial gut-wrenching change
to reposition the firm in what was viewed as a more attractive growth opportunity. This transformation culminated in the firm
being acquired in 2004 by News Corp., a global media empire.
To accomplish this transformation, Hughes divested its communications satellite businesses and its auto electronics
operation. The corporate overhaul created a firm focused on direct-to-home satellite broadcasting with its DirecTV service
offering. DirecTV's introduction to nearly 12 million U.S. homes was a technology made possible by U.S. military spending
during the early 1980s. Although military spending had fueled much of Hughes' growth during the decade of the 1980s, it was
becoming increasingly clear by 1988 that the level of defense spending of the Reagan years was coming to a close with the
winding down of the cold war.
For the next several years, Hughes attempted to find profitable niches in the rapidly consolidating U.S. defense contracting
industry. Hughes acquired General Dynamics' missile business and made 15 smaller defense-related acquisitions. Eventually,
Hughes' parent firm, General Motors, lost enthusiasm for additional investment in defense-related businesses. GM decided that,
if Hughes could not participate in the shrinking defense industry, there was no reason to retain any interests in the industry at
all. In November 1995, Hughes initiated discussions with Raytheon, and two years later, it sold its aerospace and defense
business to Raytheon for $9.8 billion. The firm also merged its Delco product line with GM's Delphi automotive systems. What
remained was the firm's telecommunications division. Hughes had transformed itself from a $16 billion defense contractor to a
svelte $4 billion telecommunications business.
Hughes' telecommunications unit was its smallest operation but, with DirecTV, its fastest growing. The transformation was
to exact a huge cultural toll on Hughes' employees, most of whom had spent their careers dealing with the U.S. Department of
Defense. Hughes moved to hire people aggressively from the cable and broadcast businesses. By the late 1990s, former
Hughes' employees constituted only 15–20 percent of DirecTV's total employees.
Restructuring continued through the end of the 1990s. In 2000, Hughes sold its satellite manufacturing operations to Boeing
for $3.75 billion. This eliminated the last component of the old Hughes and cut its workforce in half. In December 2000,
Hughes paid about $180 million for Telocity, a firm that provides digital subscriber line service through phone lines. This
acquisition allowed Hughes to provide high-speed Internet connections through its existing satellite service, mainly in more
remote rural areas, as well as phone lines targeted at city dwellers. Hughes now could market the same combination of high-
speed Internet services and video offered by cable providers, Hughes' primary competitor.
In need of cash, GM put Hughes up for sale in late 2000, expressing confidence that there would be a flood of lucrative
offers. However, the faltering economy and stock market resulted in GM receiving only one serious bid, from media tycoon
Rupert Murdoch of News Corp. in February 2001. But, internal discord within Hughes and GM over the possible buyer of
Hughes Electronics caused GM to backpedal and seek alternative bidders. In late October 2001, GM agreed to sell its Hughes
Electronics subsidiary and its DirecTV home satellite network to EchoStar Communication for $25.8 billion. However,
regulators concerned about the antitrust implications of the deal disallowed this transaction. In early 2004, News Corp.,
General Motors, and Hughes reached a definitive agreement in which News Corp acquired GM's 19.9 percent stake in Hughes
and an additional 14.1 percent of Hughes from public shareholders and GM's pension and other benefit plans. News Corp. paid
about $14 per share, making the deal worth about $6.6 billion for 34.1 percent of Hughes. The implied value of 100 percent of
Hughes was, at that time, $19.4 billion, about three fourths of EchoStar's valuation three years earlier.
Case Study Discussion Questions:
1. How did changes in Hughes’ external environment contribute to its dramatic 20-year restructuring effort? Cite
specific influences in answering this question. (Hint: Consider some of the motivations discussed in this chapter for
engaging in restructuring activities.). Cite examples of how Hughes took advantage of their core competencies in
pursuing other alternatives?
2. Why did Hughes’ board and management seem to rely heavily on divestitures rather than other restructuring
strategies discussed in this chapter to achieve the radical transformation of the firm? Be specific.
3. What risks did Hughes face in moving completely away from its core defense business and into a high-technology
commercial business? In your judgment, did Hughes move too quickly or too slowly? Explain your answer.
4. Why did Hughes move so aggressively to hire employees from the cable TV and broadcast industry?
5. Speculate as to why News Corp, a major entertainment industry content provider, might have been interested in
acquiring Hughes. Be specific.
