Blockbuster Nears Leaving Viacom Fold in Split-Off: The critical share-exchange ratio is still under wraps, but Viacom is set to take a big pay-off via a special cash dividend

Viacom Inc.’s long-running plan to unwind its troubled connection with Blockbuster International Inc. moved forward in June when the companies confirmed they would part ways in a tax-free split-off and unveiled a unique cash kicker that will generate a big payday for the parent. But perhaps the most critical element of the project – the ratio for swapping shares between the two companies – remained a mystery. Industry experts speculate that Viacom must dangle a hefty premium before its stockholders to persuade them to trade their shares for stock in Blockbuster and its uncertain prospects. That means the value of Blockbuster stock offered should exceed the value of the Viacom stock surrendered to make the deal work. The split-off allows a restructuring company to dispose of a subsidiary tax-free while shrinking its own float of outstanding shares. The offer typically is oversubscribed, i.e., the divesting parent is offered more of its shares than it sought. Blockbuster, however, needs a sweetener because its business is being challenged by market developments including low DVD prices and cheap web-based DVD rentals. Viacom began shedding Blockbuster when it sold nearly a 19% stake to the public in 1999, and has suggested ever since that a complete divorce was in the offing. Meanwhile, the project added what is believed to be a first-time restructuring wrinkle – payment of a $5-per-share special dividend – a total of about $905 million – by Blockbuster just before the split-off is executed. Viacom’s stake entitles it to $738 million, which will come tax-free because it represents a recovery of the parent’s basis in Blockbuster shares. Blockbuster is to borrow $1.45 billion to finance the payout. This is a variation on the upstream dividend to the parent that is common in spin-offs. Robert Willens, a managing director at Lehman Brothers, says Viacom has room to build a big premium into the exchange ratio without jeopardizing the tax-free character of the divorce. “The IRS has not signed off on premiums generally, so even though you are receiving more in value than you are surrendering, that excess is not treated as income,” he says. Going “in hock to pay the dividend,” intensifies the need for a hefty premium, he says, adding, “It may take a substantial premium to get people to participate at least to the minimum acceptable number (of shares) that Viacom is looking for.” Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com