21
The Anatomy of a Spin-Off—Northrop Grumman Exits
the Shipbuilding Business
_____________________________________________________________________________________
Case Study Objectives: To illustrate
• The advantages and disadvantages of alternative restructuring strategies and
• How spin-offs may be structured.
______________________________________________________________________________
In an effort to focus on more attractive growth markets, Northrop Grumman Corporation (NGC), a global leader in aerospace,
communications, defense, and security systems, announced that it would exit its mature shipbuilding business on October 15,
2010. Huntington Ingalls Industries (HII), the largest military U.S. shipbuilder and a wholly owned subsidiary of NGC, had
been under pressure to cut costs amidst increased competition from competitors such as General Dynamics and a slowdown in
orders from the U.S. Navy. Nor did the outlook for the shipbuilding industry look like it would improve any time soon.
Given the limited synergy between shipbuilding and NGC’s other businesses, HII’s operations were largely independent of
NGC’s other units. NGC’s management and board argued that their decision to separate from the shipbuilding business would
The spin-off represented about one-sixth of NGC’s $36 billion in 2010 revenue. Effective March 31, 2011, all of the
outstanding stock of HII was spun off to NGC shareholders through a pro rata distribution to shareholders of record on March
30, 2011. Each NGC shareholder received one HII common share for every six shares of NGC common stock held.5
Post-Merger Structure
P&G Shareholders
Coty Shareholders
Figure 16.3 Reverse Morris Trust Split-Off Transaction
The spin-off process involved an internal reorganization of NGC businesses, a Separation and Distribution Agreement, and
finally the actual distribution of HII shares to NGC shareholders. The internal reorganization and subsequent spin-off is
illustrated in Figure 16.3. NGC (referred to as Current Northrop Grumman Corporation) first reorganized its businesses such
Following the spin-off, HII became a separate company from NGC, with NGC having no ownership interest in HII.
Renamed Titan II, Current NGC became a direct, wholly owned subsidiary of HII and held no material assets or liabilities
other than Current NGC’s guarantees of HII performance under certain HII shipbuilding contracts (under way prior to the spin–
off and guaranteed by NGC) and HII’s obligations to repay intercompany loans owed to NGC. New NGC changed its name to
Northrop Grumman Corporation. The board of directors remained the same following the reorganization.
No gain or loss was incurred by common shareholders because the exchange of stock between the Current and New Northrop
Before the spin-off, HII entered into a Separation and Distribution Agreement with NGC. The Agreement governed the
relationship between HII and NGC after completion of the spin-off. It also provided for the allocation between the two firms of
assets, liabilities, and obligations (e.g., employee benefits, intellectual property, information technology, insurance, and tax-
related assets and liabilities). The Agreement also provided that NGC and HII each would indemnify (compensate) the other
aggregation of all fractional shares, which were subsequently sold in the public market. The cash proceeds were then
distributed to NGC shareholders on a pro rata basis and were taxable to the extent a taxable gain is incurred by the shareholder.
23
Figure 16.3 Spin-Off Illustration
Discussion Questions
1. Speculate as to why Northrop Grumman used a spin-off rather than a divestiture, split-off or split up to separate
Huntington Ingalls from the rest of its operations? What were the advantages of the spin-off over the other
restructuring strategies.
Northrop
Grumman
Systems
(NGSC)
Northrop
Grumman
Shipbuilding
(NGSB)
Huntington Ingalls
Industries (HII)
Northrop
Grumman
Systems Corp.
(NGSC)
New Northrop
Grumman
(New NGC)
Public
Shareholders
Public
Shareholders
Northrop Grumman
(Formerly New NGC)
Huntington Ingalls
Industries (HII)
Public
Shareholders
Public
Shareholders
NGC Pre-Internal Reorganization NGC Post-Internal Reorganization
NGC Post-Spin-Off HII Post-Spin-Off
24
Answer: Spin-offs may involve businesses which are first transferred to a newly formed wholly-owned subsidiary
corporation, with the stock of that corporation then distributed to the shareholders of the parent firm. Other times, the
stock of a pre-existing subsidiary is distributed. Section 355 of the U.S. Tax Code permits the division of a
corporation tax-free, including a spin-off, split-off, and split-up. A spin-off involves a pro rata distribution of a
2. What is the likely impact of the spin-off on Northrop Grumman’s share price immediately following the spin-off of
Huntington Ingalls assuming no other factors offset it?
Answer: Assuming nothing else changes, the immediate impact on NGC’s share price would be to lower it by the
3. Why do businesses that have been spun off from their parent often immediately put antitakeover defenses in place?
Answer: Antitakeover defenses are put in place to reduce the likelihood that a change in control can take place as a
4. Why would the U.S. Internal Revenue Service be concerned about a change of control of the spun-off business such
that it might revoke its ruling that the spin-off satisfied the requirements to be tax-free?
Answer: The IRS is concerned that a spin-off may be used for tax avoidance rather than for a sound business purpose.
A sound business purpose could include simplifying the parent’s structure or giving the spun off firm more direct
.
5. Describe how you as an analyst would estimate the potential impact of the Huntington Ingalls Industries spin-off on
the long-term value of Northrop Grumman’s share price?
Answer: An important stated motivation for the spin-off by Northrop Grumman’s management is to simplify the
corporation, enable management to focus on those businesses it better understands, concentrate limited investment
25
The Anatomy of a Reverse Morris Trust Transaction:
The Pringles Potato Chip Saga6
Key Points
Greater shareholder value may be created by exiting rather than operating a business.
Deal structures can impose significant limitations on a firm’s future strategies and tactics.
_____________________________________________________________________________________________
Following a rigorous portfolio review and an informal expression of interest in the Pringles brand by Diamond Foods
(Diamond) in late 2009, Proctor & Gamble (P&G), the world’s leading manufacturer of household products, believed that
Pringles could be worth more to its shareholders if divested than if retained. Pringles is the iconic potato chip brand, with sales
in 140 countries and operations in the United States, Europe, and Asia.
After extended negotiations, Diamond and P&G announced on April 15, 2011, their intent to merge P&G’s Pringles
subsidiary into Diamond in a transaction valued at $2.35 billion. The purchase price consisted of $1.5 billion in Diamond
common stock, valued at $51.47 per share, and Diamond’s assumption of $850 million in Pringles outstanding debt. The way
in which the deal was structured enabled P&G shareholders to defer any gains they realize from the transaction and resulted in
a one-time after-tax earnings increase for P&G of $1.5 billion due to the firm’s low tax basis in Pringles.
The deal was structured as a reverse Morris Trust acquisition, which combines a divisive reorganization (e.g., a spin-off or a
split-off) with an acquisitive reorganization (e.g., a statutory merger) to allow a tax-free transfer of a subsidiary under U.S. law.
The use of a divisive reorganization results in the creation of a public company that is subsequently merged into a shell
subsidiary (i.e., a privately owned company) of another firm, with the shell surviving.
The structure of the deal involved four discrete steps, outlined in separation and transaction agreements signed by P&G and
Diamond. These steps included the following: (1) the creation by P&G of a wholly owned subsidiary containing Pringles’
assets and liabilities; (2) the recapitalization of the wholly owned Pringles subsidiary; (3) the separation of the wholly owned
subsidiary through a split-off exchange offer; and (4) a merger with a wholly owned subsidiary of Diamond Foods. The
separation agreement covered the first three steps, with the final step detailed in the transaction agreement.
26
tax free to P&G because it is an intracompany transfer. If the exchange offer had not been fully subscribed, P&G would have
distributed through a tax-free spin-off the remaining shares as a dividend to P&G shareholders.
Figure 16.3 Reverse Morris Trust.
P&G
Shareholders
Diamond
Shareholders
The Proctor &
Gamble Company
Diamond Foods
Pre-Merger Structure
Separation Structure before Merger
P&G Shareholders
(incl. exchange offer
participants)
Merger Sub
(Acquisition Vehicle)
Diamond
Shareholders
Post-Merger Structure
Current & Former
P&G
Sharehold
Selected
Pringles Common
27
Discussion Questions:
1. The merger of Pringles and Diamond Foods could have been achieved as a result of a P&G spin-off of
Pringles. Explain the details of how this might happen.
Answer: By creating a wholly-owned shell subsidiary, P&G could have distributed the shares to its shareholders as a dividend
2. Speculate as to why P&G chose to split-off rather than spin-off Pringles as part its plan to merge Post with Ralcorp.
Be specific.
Answer: P&G chose a split-off rather than spin-off even though either would have resulted in a tax-free transaction for its
3. Why was this transaction subject to the Morris Trust tax regulations?
Answer: The U.S. Tax Code restricts how certain types of corporate transactions can be structured to avoid taxes. Specifically,
split-offs or spin-offs implemented as part of a merger must be structured to satisfy Morris Trust tax code rules if the
transaction is to be deemed tax free. The IRS’ concern is that a split-off or spin-off of a wholly-owned parent subsidiary could
4. How is value created for the P&G and Diamond shareholders in this type of transaction?
Diamond Foods
Pringle Company (owns
Pringles assets/liabilities)
Diamond
Common
Shares
28
Answer: Ideally, the impact of taxes on investment decisions would be neutral, such that taxes would not impact how the free
market allocates capital. Resources would be transferred to those who can use them most efficiently, as they would be able to
offer the highest risk adjusted financial returns to attract investors.
5. Why did the addition of the shareholder rights plan by Diamond Foods following the merger with Pringles make sense
given the type of deal structure used?
Answer: The use of the split-off/reverse Morris Trust structure to acquire Pringles results in the transaction being tax-free to
P&G shareholders. To avoid the appearance of a “disguised sale” and requirement to pay capital gains taxes on realized book
The Anatomy of a Spin-Off—Northrop Grumman Exits the Shipbuilding Business
_____________________________________________________________________________________________
Key Points
There are many ways a firm can choose to separate itself from one of its operations.
Which restructuring method is used reflects the firm’s objectives and circumstances.
______________________________________________________________________________
In an effort to focus on more attractive growth markets, Northrop Grumman Corporation (NGC), a global leader in aerospace,
communications, defense, and security systems, announced that it would exit its mature shipbuilding business on October 15,
2010. Huntington Ingalls Industries (HII), the largest military U.S. shipbuilder and a wholly owned subsidiary of NGC, had
been under pressure to cut costs amidst increased competition from competitors such as General Dynamics and a slowdown in
orders from the U.S. Navy. Nor did the outlook for the shipbuilding industry look like it would improve any time soon.
Given the limited synergy between shipbuilding and HII’s other businesses, HII’s operations were largely independent of
NGC’s other units. NGC’s management and board argued that their decision to separate from the shipbuilding business would
enable both NGC and HII to focus on those areas they knew best. Moreover, given the shipbuilding business’s greater ongoing
capital requirements, HII would find it easier to tap capital markets directly rather than to compete with other NGC operations
for financing. Finally, investors would be better able to value businesses (NGC and HII) whose operations were more focused.
29
The spin-off process involved an internal reorganization of NGC businesses, a Separation and Distribution Agreement, and
finally the actual distribution of HII shares to NGC shareholders. The internal reorganization and subsequent spin-off is
Following the spin-off, HII became a separate company from NGC, with NGC having no ownership interest in HII.
Renamed Titan II, Current NGC became a direct, wholly owned subsidiary of HII and held no material assets or liabilities
other than Current NGC’s guarantees of HII performance under certain HII shipbuilding contracts (under way prior to the spin–
off and guaranteed by NGC) and HII’s obligations to repay intercompany loans owed to NGC. New NGC changed its name to
Northrop Grumman Corporation. The board of directors remained the same following the reorganization.
No gain or loss was incurred by common shareholders because the exchange of stock between the Current and New
Northrop Grumman corporations did not change the shareholders’ tax basis in the stock. Similarly, no gain or loss was incurred
Discussion Questions
1. Speculate as to why Northrop Grumman used a spin-off rather than a divestiture, split-off or split up to separate
Huntington Ingalls from the rest of its operations? What were the advantages of the spin-off over the other restructuring
strategies.
Answer: Spin-offs may involve businesses which are first transferred to a newly formed wholly-owned subsidiary corporation,
with the stock of that corporation then distributed to the shareholders of the parent firm. Other times, the stock of a pre-existing
subsidiary is distributed. Section 355 of the U.S. Tax Code permits the division of a corporation tax-free, including a spin-off,
split-off, and split-up. A spin-off involves a pro rata distribution of a controlled corporation’s stock to the parent’s
shareholders, while a split-off may be pro rata or a non-pro rata distribution of a controlled subsidiary’s stock to one or more of
30
2. What is the likely impact of the spin-off on Northrop Grumman’s share price immediately following the spin-off of
Huntington Ingalls assuming no other factors offset it?
Answer: Assuming nothing else changes, the immediate impact on NGC’s share price would be to lower it by the amount of
3. Why do businesses that have been spun off from their parent often immediately put antitakeover defenses in place?
Answer: Antitakeover defenses are put in place to reduce the likelihood that a change in control can take place as a result of an
4. Why would the U.S. Internal Revenue Service be concerned about a change of control of the spun-off business such
that it might revoke its ruling that the spin-off satisfied the requirements to be tax-free?
Answer: The IRS is concerned that a spin-off may be used for tax avoidance rather than for a sound business purpose. A sound
business purpose could include simplifying the parent’s structure or giving the spun off firm more direct access to capital by
.
5. Describe how you as an analyst would estimate the potential impact of the Huntington Ingalls Industries spin-off on
the long-term value of Northrop Grumman’s share price?
Answer: An important stated motivation for the spin-off by Northrop Grumman’s management is to simplify the corporation,
enable management to focus on those businesses it better understands, concentrate limited investment resources in businesses
Figure 16.4 Spin-off Illustration.
31
Kraft Foods Splits Up in Its Biggest Deal Yet
Current Northrop
Grumman Corp
(CNGC)
New Northrop
Grumman Corp
Huntington Ingalls
Industries (HII)
Current
Northrop
Grumman
Northrop
Grumman
Shipbuilding
Public
Shareholders
Public
Shareholders
Northrop Grumman
(Formerly New NGC)
Huntington Ingalls
Industries (HII)
Public
Shareholders
Public
Shareholders
NGC Post-Spin-Off HII Post-Spin-Off
32
_____________________________________________________________________________________________________
Key Points
Investors often evaluate a firm’s performance in terms of how well it does as compared to its peers.
Activist investors can force an underperforming firm to change its strategy radically.
The Kraft decision to split its businesses is yet another example of the recent trend by highly diversified businesses to increase
their product focus.
_____________________________________________________________________________________________________
Following a successful career as CEO of PepsiCo’s Frito-Lay, Irene Rosenfeld became the CEO of Kraft Foods in 2006. As the
world’s second-largest packaged foods manufacturer, behind Nestlé, Kraft had stumbled in its efforts to increase its global
reach by growing in emerging markets. Its brands tended to be old, and the firm was having difficulty developing new, trendy
products. Rosenfeld was tasked by its board of directors with turning the firm around. She reasoned that it would take a
complete overhaul of Kraft, including organization, culture, operations, marketing, branding, and the product portfolio, to
transform the firm.
Between January 2010 and mid-2011, Kraft’s earnings steadily improved, powered by stronger sales. Kraft shares rose
almost 25%, more than twice the increase in the S&P 500 stock index. However, it continued to trade throughout this period at
a lower price-to-earnings multiple than such competitors as Nestlé and Groupe Danone. Some investors were concerned that
Kraft was not realizing the promised synergies from the Cadbury deal. Activist investors (Nelson Peltz’s Trian Fund and Bill
Ackman’s Pershing Square Capital Management) had discussions with Kraft’s management about splitting the firm. This plan
had the support of Warren Buffett, whose conglomerate, Berkshire Hathaway, was Kraft’s largest investor at that time, with a
6% ownership interest.
To avert a proxy fight, Kraft’s board and management announced on August 4, 2011, its intention to restructure the firm
radically by separating it into two distinct businesses. Coming just 18 months after the Cadbury deal, investors were initially
stunned by the announcement but appeared to avidly support the proposal avidly by driving up the firm’s share price by the end
Discussion Questions
1. Speculate as to why Kraft chose not to divest its grocery business and use the proceeds to either reinvest in its faster
growing snack business, to buy back its stock, or a combination of the two?
Answer: Many of Kraft’s grocery brands were quite old and the firm’s tax basis was probably quite low. A divestiture
would have resulted in a huge tax liability to the firm and have significantly reduced the after-tax proceeds available
for reinvesting in the remaining snack businesses or to buy back stock or to raise dividends. Furthermore, a divestiture
33
2. How might a spin-off create shareholder value for Kraft Foods shareholders?
Answer: Spin-offs create value for shareholders in a variety of ways. First, if properly structured, they are tax-free to
the parent firm’s shareholders. Second, shareholders can determine the timing of their sale of the shares. Third, units
3. 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?
Answer: If a firm’s current strategy is faltering, activist investors can force a change in direction. While the firm’s
share price did grow in excess of the S&P 500 index since 2010, it is unclear if activist investors gave the Kraft
GENERAL ELECTRIC DOWNSIZES
ITS FINANCIAL SERVICES UNIT
_____________________________________________________________________________________
Key Points
• Exiting a business can take many forms ranging from an outright sale to an initial public offering to a split-off.
• The exit can take place at a moment in time or be phased over a period of time.
• The choice of the appropriate restructuring strategy reflects an array of factors including the parent firm’s need for
cash, the availability of potential buyers, and tax considerations.
______________________________________________________________________________
Long synonymous with the word conglomerate, General Electric had skillfully managed for years its highly diverse business
portfolio profitably. GE Capital had been a major profit generator for General Electric Corporation for decades, often
contributing more than one-half of the parent firm’s operating profits. The firm’s exposure to the financial services industry
had provided sustained growth and had tended to offset some of the cyclicality of its industrial businesses. GE Capital had been
managed as a cash cow to generate new funds to finance the parent’s forays into new businesses.
All that changed with the collapse of the global financial markets in 2008. GE shares plummeted immediately following the
bankruptcy of mega investment bank Lehman Brothers, as investors expressed concern about the conglomerate’s ability to
support its financial services businesses. Huge holdings of commercial loans whose value was questionable along with its
substantial risk exposure as a subprime residential home loan lender raised the prospect that GE Capital would be forced into
bankruptcy.
34
possible. The proceeds of the IPO were used to pay certain intercompany loans owed to General Electric Corporation and to
add to the new company’s capital base.
In 2015, GE will completely exit the remaining 80% of its retail finance business through a so-called transaction consisting
of a tax-free distribution of its remaining interest in Synchrony to GE shareholders willing to exchange their shares of GE
common for Synchrony Financial shares. Any remaining shares in Synchrony not disposed of through the share exchange will
be paid out as a dividend to GE shareholders. In doing so, GE will be totally rid of its retail finance unit.
The Warner Music Group is Sold at Auction
_____________________________________________________________________________________________________
Key Points
In selling a business, a firm may choose either to negotiate with a single potential buyer, to control the number of potential
bidders, or to engage in a public auction.
The auction process often is viewed as the most effective way to get the highest price for a business to be sold; however, far
from simple, an auction can be both a chaotic and a time-consuming procedure.
Auctions may be most suitable for businesses whose value is largely intangible or for “hard–to–value” businesses.
____________________________________________________________________________________________________
In early 2011, the Warner Music Group (WMG), the third largest of the “big four” recorded-music companies, consisted of two
separate businesses: one showing high growth potential and the other with declining revenues. Of WMG’s $3 billion in annual
In 2004, Warner Music’s parent at the time, Time Warner Inc., agreed to sell the business to a consortium led by THL
Partners for $2.6 billion in cash. The group also included Edward Bronfman, Jr. (the Seagram’s heir, who also became the
CEO of WMG), Bain Capital, and Providence Equity Partners. Having held the firm for seven years, a long time for private
equity investors, its primary investors were seeking a way to cash out of the business, whose long-term fortunes appeared
By the end of January 2011, WMG had solicited about 70 potential bidders and attracted unsolicited indications of interest
from at least 20 others. As this group winnowed through the auction’s three rounds, alliances among the bidders continually
changed. In the ensuing auction, WMG’s stock price jumped by 75% from $4.72 per share on January 20 to $8.25 per share,
for a total market value of $3.3 billion on May 6, 2011.
In view of the differences between these two businesses, WMG was open to selling the firm in total or in pieces,
contributing to the extensive bidder interest. Risk takers were betting on an eventual recovery in recorded-music sales, while
risk-averse investors were more likely to focus on music publishing. Prior to the auction, WMG distributed confidentiality
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
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
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
Discussion Questions
1. In your judgment, did the breakup of Motorola make sense? Explain your answer.
36
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
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.9 Kraft later converted to cash the securities received from Kraft Sub by selling them to a consortium of banks.
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,10 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.
Discussion Questions and Answers:
1. What does the decision to split up the firm say about Kraft’s decision to buy Cadbury in 2010?
9 The intracompany transfer of certain assets and associated liabilities is considered a tax-free event if it complies with the requirements of a D reorganization under Section 355 of the U.S.
Internal Revenue Code.
10 Split-offs and spin-offs undertaken as part of a merger must be structured to satisfy Morris Trust tax code rules if they are to be tax free. Such rules require that the shareholders of the parent
undertaking the split-off or spin-off end up as majority shareholders in the merged firm.
11 The $660 million represents the book value of the debt on the merger closing date. The more correct representation in calculating the purchase price would be to estimate its market value.
37
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?
Answer: Many of Kraft’s grocery brands were quite old and the firm’s tax basis was probably quite low. A divestiture
would have resulted in a huge tax liability to the firm and have significantly reduced the after-tax proceeds available
for reinvesting in the remaining snack businesses or to buy back stock or to raise dividends. Furthermore, a divestiture
3. How might a spin-off create shareholder value for Kraft Foods shareholders?
Answer: Spin-offs create value for shareholders in a variety of ways. First, if properly structured, they are tax-free to
the parent firm’s shareholders. Second, shareholders can determine the timing of their sale of the shares. Third, units
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?
Answer: While the firm’s share price did grow in excess of the S&P 500 index since 2010, it is unclear if activist