21
agreements to 37 suitors, with 10 actually submitting a preliminary bid by the deadline of February 22, 2011. Of the
preliminary bids, four were for the entire company, three for recorded music, and three for music publishing. For the entire
firm, prices ranged from a low bid of $6 per share to a high bid of $8.25 per share. For recorded music, bids ranged from a low
of $700 million to a high of $1.1 billion. Music publishing bids were almost twice that of recorded music, ranging from a low
of $1.45 billion to a high of $2 billion.
For bidders, the objective is to make it to the next round in the auction; for sellers, the objective is less about prices offered
during the initial round and more about determining who is committed to the process and who has the financial wherewithal to
consummate the deal. According to the firm’s proxy pertaining to the sale, released on May 20, 2011, the subsequent bidding
was characterized as a series of ever-changing alliances among bidders, with Access Industries submitting the winning bid. The
sale appears to have been a success from the investors’ standpoint, with some speculating that THL alone earned an internal
rate of return (including dividends) of 34%.3
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.
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.4 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,5 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.6 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?
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?
24
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.7
Sara Lee Attempts to Create Value through Restructuring
7 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
25
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.
27
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.
While the transaction did not provide any cash directly to the firm, it did indirectly augment Bristol–Myer’s operating cash
flow by $214 million annually. This represented the difference between the $350 million that Bristol-Myers paid in dividends
to Mead Johnson shareholders and the $136 million it received in dividends from Mead Johnson each year. By reducing the
number of Bristol-Myers shares outstanding, the transaction also improved Bristol–Myers’ earnings per share by 4% in 2011.
Finally, by splitting-off a noncore business, Bristol-Myers was increasing its attractiveness to investors interested in a “pure
play” in biotechnology pharmaceuticals.
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.
28
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.
Verizon announced that the spin-off would enable the parent and Idearc to focus on their core businesses, which may
facilitate expansion and growth of each firm. The spin-off would also allow each company to determine its own capital
structure, enable Idearc to pursue an acquisition strategy using its own stock, and permit Idearc to enhance its equity-based
compensation programs offered to its employees. Because of the spin–off, Idearc would become an independent public
company. Moreover, no vote of Verizon shareholders was required to approve the spin-off, since it constitutes the payment of a
dividend permissible by the board of directors according to the bylaws of the firm. Finally, Verizon shareholders have no
appraisal rights in connection with the spin–off.
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.
29
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.
The actual ratio at which shares of Bristol-Myers common stock and shares of Mead Johnson common stock were
exchanged was determined by computing a simple three-day average of the shares of the two firms during December 8–10,
2009, subject to the 0.6313 upper limit. On December 16, 2009, Bristol-Myers announced it would exchange up to 170 million
share of Mead Johnson common stock (i.e., all that it owned) for outstanding shares of its stock at an exchange ratio of 0.6313
shares of Mead Johnson common stock for each share of Bristol–Myers common stock tendered and accepted in the exchange
offer.
Assuming that the three-day average of BMS and MJ share prices was $24.30 and $43.75, respectively, BMS shareholders
whose tendered shares were accepted in the exchange offer received the higher of $26.97 (i.e., $24.30 × 1.11) or $27.62 (i.e.,
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.
American Express announced plans in early 2005 to jettison its financial advisory business through a tax-free spin-off
to its shareholders. The firm also noted that it would incur significant restructuring-related expenses just before the spin-off.
Such one-time write-offs by the parent are sometimes necessary to “clean up” the balance sheet of the unit to be spun off and
unburden the newly formed company‘s earnings performance. American Express anticipated substantial improvement in future
financial returns on assets as it will be eliminating more than $410 billion in assets from its balance sheet that had been
generating relatively meager earnings.
30
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
Cash accumulated from the long-distance business was spent on a variety of ill–conceived strategies such as the firm’s foray
into the personal computer business. After years of unsuccessfully attempting to redefine the company’s strategy, AT&T once
again resorted to a major restructure of the firm. In 1996, AT&T spun-off Lucent Technologies (its telecommunications
equipment business) and NCR (a computer services business) to shareholders to facilitate Lucent equipment sales to former
AT&T operations and to eliminate the non-core NCR computer business. However, this had little impact on the AT&T share
price.
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
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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.
AT&T tried to do too much too quickly. New initiatives such as high-speed internet access and local telephone services
over cable-television network were too small to pick up the slack. Much time and energy seems to have gone into planning and
acquiring what were viewed as key building blocks to the strategy. However, there appears to have been insufficient focus and
realism in terms of the time and resources required to make all the pieces of the strategy fit together. Some parts of the overall
strategy were at odds with other parts. For example, AT&T undercut its core long-distance wired telephone business by offers
of free long-distance wireless to attract new subscribers. Despite aggressive efforts to change the culture, AT&T continued to
suffer from a culture that evolved in the years before 1996 during which the industry was heavily regulated. That atmosphere
bred a culture based on consensus building, ponderously slow decision-making, and a low tolerance for risk. Consequently, the
AT&T culture was unprepared for the fiercely competitive deregulated environment of the late 1990s (Truitt, 2001).
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
On July 10, 2001, AT&T Wireless Services became an independent company, in accordance with plans announced during the
2000 restructure program. AT&T Wireless became a separate company when AT&T converted the tracking shares of the
mobile-phone business into common stock and split-off the unit from the parent. AT&T encouraged shareholders to exchange
their AT&T common shares for Wireless common shares by offering AT&T shareholders 1.176 Wireless shares for each share
of AT&T common. The exchange ratio represented a 6.5 percent premium over AT&T’s current common share price. AT&T
Wireless shares have fallen 44 percent since AT&T first sold the tracking stock in April 2000. On August 10, 2001, AT&T
spun off Liberty Media.
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
34
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
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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
36
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
37
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.