Capital Markets

Cloning and Cleaving: The Successful Execution of a Complex Spin-off 

By November 17, 2021No Comments

Capital markets insights from a NeuGroup member’s journey helping spinning off businesses intertwined within the parent.

Not all spin-offs are created equal—a lesson brought home powerfully to one NeuGroup member who helped their company successfully navigate a large, complex, nearly two-year spin-off of three product groups that did not formerly exist as stand-alone businesses and were not managed as a group by the parent company.

  • “These products were fully intertwined across every aspect of the business,” they said. So were the systems used by the three groups, including those for accounts payable, accounts receivable and payroll— “every system that we have, fully intertwined.”
  • At the fall meeting of NeuGroup for Capital Markets, the assistant treasurer (AT) described it as “one of the toughest, most challenging” projects they’ve undertaken during a decades-long career in treasury that included working on many complex transactions.
  • For the entire company, “from a human body perspective, it was like trying to clone every single organ and body part you have and then sending that body off to go live its own life,” they said, laughing.
  • For treasury, the process involved new legal entities, global bank accounts, pooling structures and treasury management systems as well as setting up new pensions, benefits, insurance, ISDAs and the treasury organization itself.

Start with the balance sheet and cash flow forecast. The member told peers that from a capital markets perspective, “the foundational financial data for a spin is the most critical thing that you need.” But unlike most capital markets transactions, treasury in this spin-off did not have the needed information available in 10-K filings or pro forma data prepared by accounting teams. “That didn’t exist,” they said. That meant lots of complexity and collaboration.

  • “For us to prepare a forecast of the balance sheet and cash flows, we have to pull in all these people who are struggling with, ‘what’s the boundary around this business, how do we segregate it out?’” they said.
  • For the balance sheet, the complexities include deciding what tax and legal liabilities go on the books of the spun off entity as well as estimating pension liabilities “when you don’t know who the people are—are they one-year hires or are they 30-year tenured employees?”
  • They advised peers, “Make sure when you do a spin that you have line of sight to financial data. Does it exist, does it not?”
  • Realize that accountants will be preparing a Form 10, a precursor to a 10-K, that is focused on actuals but that treasury will also need a Form 10 with pro forma figures—both of which are difficult to create in a situation where the spun-off entity does not yet exist.
  • One key lesson learned: the timeline to issue debt on behalf of the spin-off company—a major component of the process—was constrained by the need to wait until the Form 10 was complete and filed with the SEC, something that couldn’t happen until after the completion of the parent’s financial filings.

Expect a bevy of banks to reach out. Financial institutions that are in a corporate’s bank group and all those that have been trying to get in, including diversity firms, will approach treasury in the wake of a spin-off announcement, the AT said, adding, “You have to be prepared to carve out time for those discussions.”

  • The treasury team met with every bank in the corporate’s bank group to make sure they had “a fair playing field” to compete to join the spin-off’s banking group.
  • Among the issues facing treasury are how many tiers the spin-off’s bank group will have and how many banks will go in each tier. They debated whether to have a flat, single tier but ultimately chose a two-tier structure.
  • Deciding which banks will join the spin-off’s group requires considering the spin-off’s operational needs and whether it will, for example, have a FX hedging program or a pension plan. The goal is picking banks that can meet the new company’s needs and provide a “fairly seamless transition,” they said.

Capital structure and credit ratings. The AT needed to guide decisions on an appropriate capital structure for the spin-off, informed by credit rating considerations. “Are they better off as low investment grade with risk of slipping into high yield or as high yield with different challenges?” was one question, they said.

  • Another option: a split rating that would require getting a third rating to break the tie. Among the factors to consider, treasury must weigh what credit rating the spin-off’s financial projections will support as well as the perspective of the new company’s management.
  • “You hate to spin off a company with a certain rating and then that management goes off and takes actions and the rating changes,” the AT said. “It’s not great for investors and it feels like a little bit of a disconnect.”
  • In the end, the spin-off was rated high yield and has secured debt and term loans. The member said the complexity with secured debt is determining which assets will secure the debt, an issue of great importance with potential tax implications.
    • The parent is rated investment grade and its debt is entirely unsecured. Both companies pay dividends, and each have USD and euro debt.
  • In addition to financial forecasts and scenarios, treasury was involved in creating extensive presentation materials to explain every aspect of the businesses, strategy and financials of the spin-off to rating agencies and debt investors. “Do not underestimate the amount of time you will spend doing that,” they advised.

Justin Jones

Author Justin Jones

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