Carve- Out Definition
A carve-out is a divesting of assets or business units that are not necessary strategically to a company for its operations. It is mainly done as a part of the company’s growth strategy.
Carveouts are used in numerous situations, as discussed below
A little More on What is a Carve out
Management Incentive Plan -Carve Out– This is a scenario where company managers are given a form of liquidation preference i.e. they receive a percentage of the value obtained from selling the company. For an instance, when the company sells for a certain amount, the creditors will be paid first and the remaining amount will be distributed to stockholders. If there is a carve-out, the managers benefiting from it will receive a certain amount up front; thus the carve-out gives the managers a preference above shareholders.
Equity Financing Carve-out – An equity financing carve out is used when other ways of obtaining financial resources encounter serious difficulties. It consists of the sale of the shares of a corporate subsidiary in the financial markets. An IPO of a package of shares is a mechanism for obtaining carve-out financing . The sale generally represents 20-40 percent of the company’s capital stock. An operation of this type is carried out because of the belief that the value of the separate subsidiary is greater than that of the business group as a whole. Some examples of equity carve-out operations include; American Express in 1987 when it sold 39 percent of Shearson Lemon or DuPont in 1998 when it sold 30 percent of Conoco.
Spin-off – This is a process by which a separate company is created from another existing entity. With time, the company that was formed is split from the latter. This business strategy consists of encouraging and supporting workers from the original company to leave and create their own company. An example of spin-off is this projects whose purpose is the independence of any of the departments or divisions of the company. There are two kinds of spin-off based on its origin; the business spin-off which refers to when the new company comes from another previous organization. Another kind is the academic spin-off and it starts in university centers and research institutes. Some of the reasons that explain the creation of a spin-off may include:
- The retention of talent,
- The formation of new business niches
- Company survival
- Commercial or labor planning, or
- a specific financial dynamic.
Three advantages of a spin off stand out
- Entrepreneurs will be able to continue developing the business area that was generated in the beginning until reaching the final product,
- the university will be able to boost its transfer work in terms of the results of the research, and
- the company will benefit from the qualified jobs that directly result from the spin-offs.
References for Carve Out
Academic Research on Carve Outs
- Capital markets and corporate structure: the equity carve–outs of Thermo Electron1, Allen, J. W. (1998). Journal of Financial Economics, 48(1), 99-124. This article provides an in-depth analysis of Thermo Electron Corporation(TEC), providing information on the innovative corporate structure. The company’s units are subjected to scrutiny of the capital market by carve-outs; this enables the company’s compensation contracts to be based on market performance as well as transform investment decisions and capital acquisition from centralized control to unit managers. The article argues that Thermo carve-outs increase capital and R&D expenditures following carve-outs and generate significant value from their capital investments.
- A comparison of equity carve–outs and seasoned equity offerings: Share price effects and corporate restructuring, Schipper, K., & Smith, A. (1986). Journal of Financial Economics, 15(1-2), 153-186. This article explores how parent firms’ share prices react to announcement of the public stock offerings of wholly-owned subsidiaries. The difference between the average abnormal gains and average abnormal losses in relation to equity carve-out announcements have been outlined by the author. It also discusses the four features distinguishing equity carve-outs from parent equity offerings. The evidence on these features are also provided including the positive average share price reaction resulting from equity carve-outs announcements.
- Equity carve–outs: a new spin on the corporate structure, Anslinger, P., Carey, D., Fink, K., & Gagnon, C. (1997). The McKinsey Quarterly, (1), 165-173. This paper discusses the concept of equity carve-outs and its impact on corporate structure, it shows how the concept of an equity carve-out promotes innovation and growth. And the effects it has on human resources, finance and corporate organization. One of the factors hindering the success of equity carve-outs is the application of traditional compensation and management operations.
- Breaking up is good to do: restructuring through spin offs, equity carve–outs, and tracking stocks can create shareholder value, Anslinger, P. L., Klepper, S. J., & Subramaniam, S. (1999). The McKinsey Quarterly, (1), 16-17. This paper highlights the importance of corporate restructuring in shareholder valuation. That is, the author explain how companies can create value for shareholders through the improvement of corporate governance with the aim of increasing strategic flexibility. According to the study, public announcements of tracking-stock deals tend to increase the price of the parent company’s stock by 2-3 percent.
- Corporate restructurings: A comparison of equity carve‐outs and spin‐offs, Frank, K. E., & Harden, J. W. (2001). Journal of Business Finance & Accounting, 28(3‐4), 503-529. This paper examines the divisive corporate restructurings that every firm considers when planning to take its subsidiary public. The results obtained using the sample of 64 spin-offs and 76 carve-out firms provides the evidence that factors impacting the divestiture choice related to Master Limited partnerships differs when divesting a corporate subsidiary as studied before. The author illustrates how carve-out firms have high probability of experiencing cash constraint with lower marginal carve.
- Why issue tracking stock? Insights from a comparison with spin‐offs and carve‐outsm Chemmanur, T. J., & Paeglis, I. (2001). Journal of Applied Corporate Finance, 14(2), 102-114. This articles presents the new evidence on the effectiveness of tracking stock issues in creating shareholders value as compared to the record of spin-offs and equity-carve outs. The findings are interpreted as suggesting that the main corporative motives for issuing tracking stock are the valuation benefits from providing investors with more information about the newly listed subsidiary. From the difference between the spin-offs and equity carve-outs, the author also finds out that the market-adjusted two –year holding period return for tracking stock parents and subsidiaries is lower than the corresponding return for spinoffs and their corporate parents.
- The choice of going public: Spin-offs vs. carve–outs, Michaely, R., & Shaw, W. H. (1995). Financial Management, 5-21. This article addresses the existing different between spin-offs and equity carve-outs and how they impact asset divesting. The paper shows that riskier, more leveraged, less profitable firms choose to divest through a spin-off. The spin-off firms are smaller and less profitable than the carve-out firms thus the choice is affected by a firm’s access to the capital market. Greater scrutiny and more stringent disclosure are required in carve-outs relative to spin-off.
- Announcement effects of new equity issues and the use of intraday price data, Barclay, M. J., & Litzenberger, R. H. (1988). Journal of Financial Economics, 21(1), 71-99. This article explores how intraday market reacts to the announcements of new equity issues. After the announcements, there is abnormally high volume and a negative average return. Issue size, intended use of proceeds and estimated profitability of new investment are uncorrelated with the announcement effect. After new shares have been issued, a significant price recovery is witnessed, up to 1.5 percent. The author notes that this evident is not consistent with several theories that have always explained the negative market reaction as a result of new equity issues announcements.
- Equity carve‐outs and managerial discretion, Allen, J. W., & McConnell, J. J. (1998). The Journal of Finance, 53(1), 163-186. This study proposes a managerial discretion hypothesis of equity carve-outs in which managers value control over assets and are reluctant to carve out subsidiaries. According to this hypothesis, firms that carve out subsidiaries exhibit poor operating performance and high leverage prior to carve-outs.
- How strategy shapes structure, Kim, W. C. (2010). Strategic Direction, 26(2). This article describes how an organization’s strategic approaches can influence its performance and management structure.
- Deciphering the motives for equity carve‐outs, Powers, E. A. (2003). Journal of Financial Research, 26(1), 31-50. This article attempts to analyze the effects of equity carve-outs. As such, the author analyzes 181 equity carve-outs in order to understand whether the transactions are motivated by potential efficiency improvements or by the existing opportunity to sell overvalued equity. According to the author, if there is a correlation between subsequent performance and parent managers’ degree of believing that carve-out subsidiaries are over or undervalued, many carve-outs are conducted to sell potentially overvalued equity.