Deciding on Transaction Type  627 must pay income tax on gains from a business sale. Businesses with relatively high ROIC or low capital intensity may therefore be less attractive candidates for an outright sale unless the premium offered justifies the capital gains tax. In many European countries, the so-called participation exemption makes the sale of the parent’s shares in a subsidiary exempt from taxes. Public Transactions If the company cannot identify another company as a better owner, it can consider public restructuring alternatives. All the public transactions in the preceding list involve the creation of a new public security, but not all of them actually result in cash proceeds. Full IPOs and carve-outs result in cash proceeds as securities are sold to new shareholders. In spin-off and split-off transactions, new securities are offered to existing shareholders, sometimes in exchange for other existing shares (split-offs). In public transactions, shareholders do not earn a premium from the dives- titure itself, but significant value may be created for shareholders in the future. For example, if industry consolidation is expected, a public transaction may be more beneficial for the shareholders in the long term if the newly floated business unit would drive the consolidation or would be a takeover candidate. Spin-Offs  The most common form of public-ownership transaction is a spin- off. In the case of a spin-off, the parent company gives up control over the business unit by distributing the subsidiary shares to the parent’s shareholders. This full separation maximizes the strategic flexibility of the subsidiary, pro- vides the greatest freedom to improve operations by sourcing from more competitive companies (instead of the former parent), and avoids conflicts of interest between the parent company and the business unit. Spin-offs are usually carried out to improve operating performance of the business units. Depending on the jurisdiction, spin-offs can also offer tax benefits over alternatives such as trade sales and IPOs. In the United States, United King- dom, and several countries of continental Europe, spin-offs can be structured as tax-free transactions. Such benefits can make a spin-off more value-creating for shareholders than a trade sale at a sizable premium in countries such as the United States, where gains from a trade sale are taxed. Consider a hypotheti- cal example in which a business with a tax book value of $200 million can be sold for $1.2 billion or spun off at an expected market capitalization of $1 bil- lion. At a tax rate of 25 percent, the sale would leave the parent company with after-tax proceeds of $950 million that it could return to its shareholders. In a spin-off, the parent company would distribute shares in the business with an expected value of $1 billion to its shareholders. Sometimes spin-offs are executed in two steps: a minority IPO (carve-out) followed by a full spin-off relatively shortly thereafter. Some advocates claim that a two-step spin-off has benefits: the initial minority listing establishes 628  Divestitures dedicated equity coverage, creates market making in the shares, and may re- duce the risk of price pressure from flow-back by developing an interested investor base.17 However, in most situations, these potential issues are rarely material and can be well managed in a one-step spin-off. For example, when Siemens spun off its OSRAM lighting business in 2013, some analysts and investors were concerned about flow-back because they considered OSRAM as one of Siemens’s least attractive businesses. But the flow-back was effec- tively handled in a so-called balancing book that was used to match supply and demand for the OSRAM shares. No price pressure occurred. A one-step spin-off has the benefit of being less complex and does not depend on market circumstances, as no shares need to be sold to investors. The evidence shows that spin-offs typically lead to significant improve- ments in operating margins for both parents and spun-off businesses during the five years after the transaction’s completion. For the spun-off businesses studied, growth rates nearly doubled in this time span.18 Academic research confirms the improvements in operating performance, with larger improve- ments for the subsidiary than for the parent company.19 Some research con- cludes that operating improvements were significant only for focus-improving spin-offs—that is, transactions where the business spun off was different from the parent’s core line of business.20 Post-transaction total shareholder returns (TSR) for spin-off parents and subsidiaries are consistent with the results on operating improvements (see Exhibit 32.4). Academic research also shows that focus-improving spin-offs drive the subsidiaries’ positive performance. Transactions that did not im- prove focus had mostly negative post-transaction returns.21 17 In a spin-off, all parent shareholders receive shares of the spun-off subsidiary. When parent share- holders subsequently sell these shares in the stock market, this gives rise to flow-back. 18 See Huyett and Koller, “Finding the Courage to Shrink.” 19 Cusatis, Miles, and Woolridge, “Some New Evidence.” 20 L. Daley, V. Mehrotra, and R. Sivakumar, “Corporate Focus and Value Creation: Evidence from Spin- offs,” Journal of Financial Economics 45 (1997): 257–281. Exhibit 32.4  Long-Term Market Performance of Spin-Offs Cumulative TSR for 2-year post-transaction period, % Subsidiaries Parents Average, market index adjusted1 Median, market index adjusted2 • Focus-improving • Not focus-improving –1.9 13.1 8.6 5.4 3.1 7.4 1 Adjusted for either U.S. or European market index. 2 Adjusted for median return of index constituents over similar measurement period. Source: Datastream; Compustat. 21 Cusatis, Miles, and Woolridge, in “Some New Evidence,” find similar shareholder returns for parents and subsidiaries.