AT&T and U S WEST scored points with investors, but PacTel's AirTouch deal failed to move the market.ell before the Telecommunications Act of 1996 was signed, it had become abundantly clear to telephone companies that they would need to change their organizational or corporate structures to keep pace with the changing business and regulatory climate.
The question, however, was how to make that structural change pay off on Wall Street (em how to use the reorganization to attract attention in the market and thus secure a financial reward for both stockholders and customers.
One option (em a structural separation of regulated from unregulated business segments (em would appear logical and might even boost efficiency by allowing managers to focus separately on each segment of the business. For example, a separation into business segments would arguably concentrate asset groups with similar earnings, dividend, and risk characteristics (em more so than if the parent firm continued to hold both regulated and unregulated segments. Moreover, the separation of assets into concentrated groups may help solve problems related to dividend policy. (Payout ratios appropriate for a regulated, slow-growth monopoly make less sense for a competitive firm, which must retain a higher proportion of its earnings.)
If a structural separation is deemed appropriate, then the choices come down to 1) a spinoff of the unregulated from the regulated business, or 2) the issuance of targeted stock, which allows trading of isolated equity for the particular, targeted business segments, but maintains a unified management structure.
Here, we analyze the impacts of the separations that have occurred recently (spinoffs and issues of targeted stock) to determine their impact upon shareholders and
customers. To make the analysis more useful, we have kept the comparison to companies within a similar risk group by limiting the analysis to structural changes in AT&T and the regional Bell operating companies (RBOCs). Specifically, we compare the impacts upon shareholders and ratepayers of three restructuring announcements:
s Pacific Telesis (em the spinoff of AirTouch, announced on December 14, 1992
s AT&T (em the spinoff of business segments into "new AT&T," NCR, and Lucent Technologies, announced September 21, 1995
s # U S WEST (em the issuance of targeted stock in 1995 to form the Media and the Communication groups, announced April 10, 1995.
We will compare these two different methods of reorganization to determine if they have brought about similar or dissimilar impacts on shareholders and, by extension, the cost of equity capital.
This exercise may prove useful to electric utilities, as they consider whether to divest themselves of generating plants or isolate competitive assets from transmission and distribution. It may also help utilities decide whether and how to revamp their dividend payment policies.
The Benefits, in Theory
Richard D. McCormick, chief executive officer of U S WEST, stated in the 1995 annual report: "Our goal in this targeted stock plan was to unlock the value represented by two separate businesses, which we felt was not fully reflected in the price of the old U S WEST shares."
In financial markets the reaction was mixed. The Wall Street Journal ran an article by Liping and Cauley on April 10, 1995, suggesting that the reorganization was no more than financial gimmickry.1 Other analysts clearly saw it as a positive move.2 However, our interest here is with investor reaction.
Recent studies have shown that investors generally react favorably to equity reorganizations such as spinoffs.3 A recent article by Logue, Seward and Walsh identifies the aspects of a spinoff that may improve shareholder value.4 In that article, the authors identified several benefits, including:
s Enhanced access to capital markets. (Investors can better analyze the more tightly focused company where risk issues are isolated, identified, and understood.)
s Improved management incentives. (Rewards now target areas that management can control more directly.)
s Closer monitoring by market forces. (Company results are no longer distorted by allocation methods or decisions.)
In theory, the more focused firm will gain better management. Part of the increased amount investors are willing to pay for these companies may derive from their recognition that they now form better takeover targets.5
As an alternative to a spinoff, the issuance of targeted stock may offer some additional benefits. It provides some of the same advantages as a spinoff: 1) allowing investors to gain a better understanding of the value of each business, 2) providing the total company with greater flexibility in raising capital, and 3) allowing management-incentive awards of stock that reflect the performance of the group in which the employee works.
In particular, U S WEST identified one benefit of a targeted stock restructuring as the preservation of strategic, financial, and operational benefits derived by not losing the synergies of doing business as a single company. Moreover, the restructured company maintains the ability to transact a complete spinoff in the future, if desirable.
One primary disadvantage pertains for targeted stock: No legal or structural division is created between or among the entities represented by the targeted stock. The restructuring is a separation only in the accounting sense, and the market can and will react to that reality.
The financial effects of any business group within the company might still affect the results of operation, the financial position, or the market price of any other group.6 The level of indebtedness of one group can affect the credit rating of the entire company and therefore could increase the borrowing costs of other groups.7
The Results, in Actuality
The results of our analysis are summarized in the Table on page 41: "Equity Abnormal Returns: By Type of Restructuring." The model and computation method are described in the Technical Appendix.
Pacific Telesis. The announcement of the Pacific Telesis spinoff on December 14, 1992, created a very small and insignificant negative return relative to other telephone company shares on the same dates immediately around the announcement. The five-day cumulative abnormal is positive, but also insignificant compared to the return of other telephone companies. Returns are higher when the comparison is drawn against the returns of the S&P portfolio, especially the cumulative five-day return of 2.38 percent. However, all the values for Pacific Telesis using both indexes are statistically not significantly different from zero.
Therefore, it must be concluded that the first spinoff of Pacific Telesis did not yield any positive or negative impacts upon shareholders or ratepayers. By this finding we draw a different conclusion from what some previous research would suggest. Moreover, our results may indicate that a more normal spinoff yields significant gains because it typically concentrates assets and managerial focus on similar lines of business.
AT&T. By contrast, when AT&T announced its major restructuring, on September 21, 1995, it did appear to create significant,
positive, cumulative abnormal returns, whether measured over a two- or five-day period. These abnormal returns are quite large over the returns that were generated on the market portfolios over the same time periods. It is also clear that these returns were similar, regardless of market portfolio.
Thus, it is clear from our findings that AT&T's efforts to concentrate its business into segments, carried out by announcing a spinoff to shareholders, succeeded in creating a significant price appreciation around the announcement date. Stockholders clearly indicated that they think this strategic decision will improve the future of the company. In a competitive market for long distance, this move might be thought of as one that provides a lower cost of equity capital to the long-distance provider and allows the firm to lower prices for services.
Perhaps the differences between the no impact of the Pacfic Telesis spinoff and that of AT&T is one of size and magnitude. AirTouch formed a much smaller part of PacTel, while AT&T not only was a much larger company, but its spinoff basically split the entire firm into three parts. Clearly, the empirical evidence in these cases validates conclusions found by others: Namely, that concentrating the activities of a firm either with a spinoff or a selloff can boost value for shareholders and reduce the cost of equity capital (possibly lowering the cost of service as well).
U S WEST. A different tact was chosen by U S WEST when, on April 10, 1995, it announced a that it would issue targeted stock for its newly created U S WEST Media Group and U S WEST Communications Group. It appears clear from the analysis of the cumulative abnormal returns found in the Table that investors thought the U S WEST targeted stock issue would lead to improved performance.
Investors bid up the share prices around the announcement date, as indicated by the CAR value (Cumulative Abnormal Return (em see Technical Appendix) of over 3 percent for the two-day announcement effect above the return level generated by other security portfolios. These abnormal returns are significant and consistent with a decrease in the cost of equity capital associated with the restructuring effort. The market apparently agreed with Mr. McCormick's statements and indicated that the restructuring unlocked value in the separate business segments. t
Richard H. Pettway is professor of finance and director of the Public
Utility Division of the Financial Research Institute at the University of Missouri-Columbia. Dr. Pettway has a PhD in Finance from the University of Texas-Austin. He has testified and published on many financial issues concerning utilities. E-mail: rpettway@showme.missouri.edu. Judith Johnson is deputy manager telecommunication section for the Utah Division of Public Utilities, the advocacy and investigative arm of the Utah Public Service Commission. Previously, she was an electric utility common stock analyst with Salomon Brothers, Inc. in New York City. Ms. Johnson holds an MBA from Utah State University. E-mail: jjohnson@br.state.ut.us.
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