The Internet Bounce For Equity Carve-Outs A Handful of Internet and Technology Issues Carried the Split-Off Group

Equity carve-outs pulled off a major surprise in 1998. Seemingly battered by the second- half turbulence in the stock market, IPOs of corporate divisions and subsidiaries nonetheless scored one of the most impressive aftermarket price performances in recent years. In line with the general cooling of the IPO market, several carve-outs were scrubbed or put on hold to await less volatile and more receptive conditions. The inhospitable climate, which featured a sharp stock market decline in August and September and a strong rebound subsequently, knifed into carve-out volume, with only 32 companies sponsored by operating parents reaching public ownership the lowest number since 1995. That setback prompted serious questions about the viability of the carve-out as a value-creating device for operating companies and whether the general stock market would continue to accept carve-out issues that have been prominent features of IPO volume during the 1990s. But when the final numbers were toted up, the carve-out group actually had staged a remarkably brisk aftermarket run-up with an average gain of 26.6% from initial offering prices to closing prices as of December 31. That was the best performance for carve-outs since 1995. They outran the 16.1% increase in 1998 for the Dow Jones Industrial Average and nearly matched the 26.7% spurt for the Standard & Poor’s 500. The carve-out segment had an ace in the hole. It contained a packet of Internet and computer-related stocks, the very issues that exploded late in the year to help power the general stock market recovery. These issues in effect carried the carve-out group in a year when IPO volume was down, 12 of the 32 new carve-outs were selling below offering prices at year-end, and several highly touted “name” companies were turning in lackluster showings in the aftermarket. Six of the seven best-performing carve-outs which at minimum had doubled in price from their offering levels had Internet/computer connections. The two biggest run-ups, both of massive proportions, were scored by “pure” Internet stocks as uBid, an Internet auction firm, surged an astounding 611% and Ticketmaster Online-City Search, provider of ticketing services and community information, jumped 300%. Other information systems issues in the price appreciation megaclass included Cognizant Technologies Solutions, computer services, up 203.8%; MIPS Technologies, microprocessor products, up 128.6%; American Bank Note Holographics, security holograms, up 105.9%; and Maxtor, disk drives, up 100%. The other issue that joined this select group was Abgenix, maker of therapeutic antibodies, up 103.1%. Ironically, the carve-out group did not do as well in more normalized times when more divisions hit the marketplace. The 46 issues floated in 1997 went up by an average of 14%. There were 54 carve-outs in 1996, when the average gain was 18.9%. In 1995, the run-up averaged 23.3% across 34 new issues. Most of the “star” carve-outs that went public or returned to public ownership turned in modest performances. Fox Entertainment Group, the movie and TV arm of News Corp., advanced 11.7%; Heller Financial, commercial finance firm, floated by Japan’s Fuji Bank, rose 7.9%; Waddell & Reed Financial, the mutual fund management giant carved out of Torchmark Corp., was up a mere 3%; and Ziff-Davis, sold by Softbank Ltd., eked out a 2% gain. Conoco, the oil and gas firm cut loose by Du Pont Co. in one of the year’s biggest IPOs, declined 9.8% from its initial price. Heller, Waddell & Reed, and Conoco had been publicly held prior to being acquired and Fox Entertainment is the linear successor to once-public Twentieth Century-Fox Film. By contrast, cookie and biscuit maker Keebler Foods made a big-time comeback in its return to public ownership with a jump of 49.5%. On the downside, the biggest decline was suffered by Caliber Learning Systems, whose shares dropped 69.6% by year-end. Other heavy losers were ONIX Systems, 56%, and Vysis, 55.2%. At this stage in early 1999, the carve-out market is at a crossroads. A number of important issues are in the IPO backlog. Their release to the public may well depend on an improved tone and greater stability in the stock market. * Roll-Ups Roll-Up IPOs Meet Tougher Going It was feast-or-famine in 1998 for roll-up IPOs, those unique corporate creatures that take shape by simultaneously teaming consolidation mergers with public offerings. There were 13 of these issues in 1998 and their aftermarket performances were highly volatile, with most of the year-end prices bullish or bearish swinging sharply from offering prices. On balance, however, the group, composed of what some professionals call “poof companies,” was in modestly positive territory with an average gain of 7.4%. The roll-up bloc took its lumps from the stock market turbulence and resulting roadblocks to new stock issues in general. The average 1998 gain contracted sharply from an impressive 23.3% increase in 1997 when there were 18 issues. The objective of most roll-up IPOs is to form as quickly as possible a corporate vehicle with the prowess, size, and resources to consolidate a highly fragmented and basically mature but very large industry. Of the 13 issues in 1998, seven rose and six dropped, and the up or down movements exceeded 30% in 10 cases. The clear-cut star in the group was Quanta Service, electrical contracting and maintenance, which vaulted 145.1%. A direct consolidation competitor, Integrated Electrical Services, was up 71.2%. Provant, provider of training and development services to businesses, climbed 67.3%. Prices went sharply south, however, for Dispatch Management Services, delivery services, down 69.3%; UniCapital, equipment rentals, down 59.9%; and Pentacon, distribution of fasteners, down 56.9%. * Spin-Offs Spin-Off Drivers Of Big Restructurings Activity in tax-free spin-offs continued brisk in 1998 as multi-business companies used them extensively to retreat from former diversification projects. In one of the most unique spin-off applications, U.S. Office Products, a relatively young company that distributes office supplies and equipment to business customers, split itself into five different companies, distributing the shares of four of them to its shareholders. The parent reestablished itself as a “pure play” in office supplies while giving up on the strategy of bundling a number of related services in the same house. Two of the newly formed offshoots, computer services firm Aztec Technology and printing and reproduction company Workflow Management, were spun off directly to U.S. Office stockholders. The other two, Navigant International, corporate travel management, and School Specialty, school supplies distributor, were dealt off in two steps, starting with IPOs and followed by spin-offs of U.S. Office’s remaining interests. One-time conglomerate Whitman Corp. completed its conversion into a “pure play” soft drink bottler by cutting loose two well-known companies auto repair chain Midas International and refrigeration equipment maker Hussman Corp. Hilton Hotels split its lodging and gambling operations by putting its casinos in a newly independent company, Park Place Entertainment. Campbell Soup used the spin-off to shed marginal businesses by creating Vlasic International. Although Vlasic is named for a constituent business that is one of the country’s largest pickle packers, its biggest operation is the Swanson frozen foods line, once a high-growth operation for Campbell but more recently a flat player in a flat market. The new management of Vlasic is trying to restore growth for Swanson and its legendary TV dinners. In five cases, the spin-offs were in conjunction with mergers and acquisitions. Parent-company targets thus were able to shed businesses that the acquirers did not want by turning them over to their stockholders. * Pick-Offs IPO Registrations Lead to Sell-Offs Four large, high-profile businesses that had been marked for divestiture by their owners through initial public offerings wound up on the selling end of mega-acquisitions in 1998. In the largest pick-off of the year, PepsiCo Inc. bought the Tropicana juice business of Seagram Co. for $3.2 billion after the sub had filed to go public. Runner-up was Cooper Automotive, the former auto parts unit of Cooper Industries Inc., which was dealt to Federal Mogul Corp. for $1.9 billion. Wesco Distribution, one of the nation’s largest distributors of electrical equipment, had been scheduled to go public as a reverse LBO but its owner, Clayton Dubilier & Rice shifted gears and sold the business outright to another financial buyer, Cypress Group, for $1.1 billion. Xerox Corp., which had planned the final stage of its exit from the insurance business by taking Crum & Forster Holdings Inc. public, decided instead to sell the unit to Fairfax Financial Holdings Ltd. for $795 million. Other pick-offs included: Strategix (a unit of AccuStaff Inc.), personnel services, sold to Ranstad NV for $850 million. Sun Apparel (reverse LBO), sportswear manufacturing, acquired by Jones Apparel Group Inc. for $212 million. Camelot Music Holdings Inc. (reverse LBO), tape and record stores, bought by Trans World Entertainment Inc. for $432.1 million. * Changing Scene Carve-Outs Become Acquisition Game The romance of the equity carve-out cooled for five companies that bought back the minority interests in publicly traded subsidiaries and retired them from the equity markets. Intriguingly, three of the five buybacks were cross-border deals, including two by European-based companies that tendered for shares of American subsidiaries. Usinor SA of France bought the public’s 46.5% interest in J&L Specialty Steel for $115 million and Koninlijke KNP BT NV of the Netherlands took full control of BT Office Products International Inc. by purchasing the outstanding 30% stake for $138.1 million. On the outbound side, Waste Management Inc. retired the public’s 20% stake in Waste Management PLC of the U.K. for $31.6 million. The highest-priced buybacks were domestic deals. Newmont Mining Corp. reassumed full control of Newmont Gold Inc. by purchasing the 6.3% it did not already own for $264.8 million. Allmerica Financial Inc. retired the public’s 17.5% in insurer Citizens Financial Corp. by paying $171 million. Carve-out companies already traded publicly also were tempting targets for strategic acquirers, and the brisk buyout activity in this area included: ATL Products Inc. (Odetics Inc.), magnetic tape libraries, acquired by Quantum Corp. for $304 million. Arco Chemical Inc. (Atlantic Richfield Corp.), specialty chemicals, acquired by Lyondell Chemical Co. for $5.6 billion. Atria Communities Inc. (Vencor Inc.), senior citizens’ living facilities, acquired by Kapson Senior Quarters Inc. for $417.1 million. Camco International Inc. (Pearson PLC), oilfield equipment, acquired by Schlumberger Ltd. for $3.1 billion. CompuServe Inc. (H&R Block Inc.), on-line information, acquired by WorldCom Inc. for $1.19 billion. Donnelley Enterprise Solutions Inc. (R.R. Donnelley & Sons Co.), electronic information, acquired by Bowne & Co. for $105.2 million. DePuy Inc. (Corange Ltd.), orthopedic products, acquired by Johnson & Johnson for $3.5 billion. Metromail Inc. (R.R. Donnelley & Sons Co.), mailing services, acquired by Great Universal Stores PLC for $837.9 million. MoneyGram Payment Systems Inc. (First Data Corp.), money transfer services, acquired by Viad Corp. for $301.1 million. PMT Services Inc. (Allstate Corp.), credit card processing, acquired by NOVA Corp. for $1.27 billion. Polygram NV (Philips NV), tapes and records, acquired by Seagram Co. for $9.9 billion. SPS Transaction Services Inc. (Morgan Stanley Dean Witter, Discover & Co.), transaction processing, acquired by Associates First Capital Corp. for $896 million. Vitalink Pharmacy Services Inc. (Manor Care Inc.), pharmacy services, acquired by Genesis Health Ventures Inc. for $690 million. Four other carve-outs were shirt-tailed to deals that centered on the acquisitions of their parent companies: Pharmaceutical Marketing Services Inc., services to pharmaceutical firms, acquired for $75.2 million by IMS Health Services Inc. which also bought its parent, Walsh International Inc. Steck-Vaughn Publishing Corp., educational publishing, acquired for $40.3 million by Harcourt General Inc. which also bought its parent, National Education Corp. XL Connect Inc., computer distribution, acquired for $88 million by Xerox Corp. which also bought its parent, Intelligent Electronics Inc. Allied Life Financial, insurance, acquired for $89.9 million in a far-ranging deal centering on Nationwide Mutual Insurance’s mega-acquisition of Allied Group. Major Self-Tenders1998 No. of Shares ValueCompany (mil) ($ mil)U.S. Office 37.0 $1,000.0 Products Co. ADVANTA Corp. 20.4 814.6Inland Steel 26.5 794.5 Industries Inc.Samsonite Corp. 10.5 420.0Corporate Express 35.0 376.3 Inc. St. Jude Medical Inc. 8.0 304.0MGM Grand Inc. 6.0 210.0Shaw Industries Inc. 10.6 132.8Alliant Techsystems 1.7 129.2 Inc. Liberty Corp. 2.4 124.8Albemarle Corp. 5.8 112.1Kirby Corp. 3.1 75.1Price Enterprises 10.5 57.8Cooker Restaurant 4.0 48.0 Corp. Cherry Corp. 2.4 36.7Source: SDC Merger & Corporate Transactions Database <\TBL>Selected Major Stock Buyback Allocations1998 Value Company ($ bil)Intel Corp. $7.6International Business 7.0 Machines Corp.Merck & Co. 5.0Pfizer Inc. 5.0Boeing Co. 4.9Dell Computer Corp. 4.6General Motors Corp. 4.0BankAmerica Corp. 3.5McDonald’s Corp. 3.5American Express Co. 3.2Morgan Stanley Dean 3.0 Witter, Discover & Co.AT&T Corp. 3.0Chase Manhattan Corp. 3.0BellSouth Corp. 3.0First Union Corp. 2.9Source: SDC Merger & Corporate Transactions Database <\TBL>Stock Buyback Allocations1994 to 1998 No. of Value SharesYear ($ bil)(bil)1994 $71.5 1.011995 96.9 1.111996 168.0 1.441997 169.3 1.271998 208.3 1.88Source: SDC Merger & Corporate Transactions Database<\TBL>