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When the Merger Doesn't Work: Saved by a Spin-Off?

Fortnightly Magazine - March 1 2000

see more of what we call pure plays. More and more companies will sell stocks based on one segment of the business."

Holzschuh explains that the investor with an appetite for a pure natural gas liquids company is not the same investor that wants to own the transmission and distribution business.

"[T&D] is a dividend-paying, low-risk, slow-growth [business] vs. a commodity-driven, much higher paying [niche] that is natural gas liquids," he says.

"[Furthermore], that may be another way the company divides itself to, in effect, have the same company they had before, but have different characteristics of each of those shares results in a much higher combined valuation."

Subsidiaries With Separate Valuations

There are three ways to create a subsidiary valued separately by the market, according to a McKinsey Quarterly Report.

1) Tracking Stocks. Also known as targeted stocks. A class of parent company stock that tracks the earnings of a division or subsidiary. Typically distributed as a dividend to shareholders in the parent company, these shares also can take the form of an IPO.

2) IPO Equity Carve-Out. An initial public offering of a stake in a subsidiary. The parent usually keeps majority ownership.

3) Dividend Spin-Off. The entire ownership of a subsidiary is divested as a dividend to shareholders.

A Spin-Off At Williams?

Joe Cornell of SPIN-OFF Advisors says that Williams Communications will have to be spun-off from its parent company so that it may increase the parent's earnings per share.

"Last year Williams, a Tulsa-based energy company, carved out Williams Communications Group, their fiber-optic group," he says. "They sold less than 20 percent to the public and they retained more than 80 percent of the shares. They still have the bulk of the control of that company."

What is interesting about Williams, says Cornell, is that now that both pieces are trading, it is easy to calculate the value of the spin-off.

"If [you] back-out their ownership stake in the [partial] spin-off, you are valuing the energy pipeline at about $3 per share. We think that the Williams Energy pipeline assets are worth about $20 a share," he says.

Cornell predicts that the parent will spin off the rest of its ownership to shareholders of Williams in the not too distant future. He explains his valuation this way:

"Since you know that Williams Communications, whose minority stake is trading in the public, you can take the shares outstanding and multiply that by the market price and come up with a market capitalization of the communication assets and multiply that by how much Williams still owns."

Williams Communications, trading under WCG, was carved out as an IPO on Aug. 11 and raised $680 million and was priced at $23, according to Cornell.

"At the end of December it was trading around $29 a share, so it was up 25 percent," he says, adding that the parent still owned 83 percent of the company. "There seems to be some inefficiency here. For whatever reasons, the telecommunication assets are getting a large valuation relative to Williams.

"We think that people like us