Having Your Cake And Selling It, TooLarry Light
In the eyes of Wall Street, tobacco and food giant RJR Nabisco Inc. is an ungainly beast. Because the stock market disdains the tobacco industry--fearing a proposed $2-per-pack cigarette tax and liability suits from cancer victims--it has punished RJR by driving the company's share price down 25% in the past two years, to just over 8.
What's a behemoth to do? Split. RJR Nabisco Holdings Corp. plans to offer stockholders separate shares in its tobacco and food arms while retaining both units under the RJR umbrella.
LONGER LEASH. The RJR solution, announced Mar. 2, will be closely watched by a slew of other big, diversified companies that want to try the same thing. Most own a problem-ridden subsidiary that is hurting the entire organization, or a healthy division buried among not-so-hot subs. With the stock market flying high, new equity cheap, the economy on the mend, and few 1980s-style raiders hovering with pesky counteroffers, such corporate cell division is catching on.
These spinoffs let companies raise money without forfeiting control of slumping subs that may stage a comeback. RJR's domestic tobacco sales are lackluster, for example, but overseas prospects show promise. At the same time, corporate parents retain such efficiencies as shared health plans and common financial systems. Since "target-stock" companies hold on to their subsidiaries, they differ from typical spinoffs, where a division is given to shareholders and becomes an independent unit, often because it doesn't fit.
Some big deals are in the works (table). Ralston Purina Co. wants to unload 55% of its underperforming Continental Baking Co. subsidiary on the market. Sears, Roebuck & Co. aims to put a 20% stake of its Allstate Insurance Co. into public hands later this year, evidently thinking that Allstate will do better in the market than its retail arm. Sears also spun off 20% of two winners, the Dean Witter Reynolds Inc. brokerage and the Discover Card, to raise money for paring debt; it will divest the rest of those units by yearend.
The largest spinoff to come should prove the most tortuous. IBM, whose mainframe division's distress overshadows successes like its workstation unit, has hired Morgan Stanley & Co. to hash out the accounting and legal complexities of selling targeted stock when the subsidiaries aren't as discrete as tobacco and food. Big Blue is convinced that a sale of workstation stock would be a bell-ringer. But disentangling IBM's cross-pollinating business activities is a puzzle--and the Securities & Exchange Commission requires three years of audited results in a subsidiary before it can peddle stock. IBM set up its present 13 business units in December, 1991, and has never done separate audits of them.
SPOTTY HISTORY. The history of major spinoffs is too brief to tell for sure whether the new round of deals will pay off. General Motors Corp. was the precursor, setting up a special Class E stock for its 1984 acquisition of Electronic Data Systems. Demand for computer services has multiplied EDS' stock sevenfold. GM followed the same route in 1985 when it bought Hughes Aircraft, but the resulting H Class stock has been a poor performer. The first big company to sell targeted stock for in-house units was USX Corp., in 1991. Its split into the U.S. Steel and Marathon Oil arms, under pressure from financier Carl C. Icahn, has produced mixed results.
One thing's certain: By isolating an attractive subsidiary, targeted-stock spinoffs can make it easier for a troubled company to raise needed equity. In addition to distributing food and tobacco common stock to existing stockholders, RJR intends to raise between $1.5 billion and $1.7 billion in a public offering of new food shares. RJR, which in 1989 became the largest leveraged buyout ever, wants to use the proceeds to pay down its $14.2 billion debt.
But do investors win? That's not clear. On one level, the unit with the better multiples stands to fetch a better price in the market. Investors can shun the bad sub and buy more of the good one, as they did with GM's Class E shares. Says Prudential Securities Inc. analyst John M. McMillin: "Separating them on paper simply has to create value." Yet no one has conclusively studied the effect of such transactions on shareholders' value.
GOOF-PROOF? In the end, even the most fortuitous spinoff won't save shareholders from poor management or a depressing business environment. Consider a 100-share investment in USX in early 1991, before the split, when company shares were 26. By early March, that $2,600 investment was worth $2,540 in spun-off U.S. Steel and Marathon Oil stock--a drop of 3%. Only after the recent market run-up did their total value exceed the level two years ago.
One advantage of targeted stock deals: They don't upset bondholders, because they won't remove major assets that support debt repayment. Consider the firestorm around Marriott Corp., which, unlike RJR, is trying to divide into two separate companies: Marriott International Inc., which operates hotels, and Host Marriott Corp., the actual owner of the hotels. Most of the old company's $2.9 billion debt would get dumped on Host Marriott. Since the plan's unveiling in the fall, the stock has surged and the bonds have nosedived. Marriott is trying to work out a compromise, but irate bondholders are pressing suits for heavy damages.
Many RJR watchers believe its split is a mechanism to permit Kohlberg Kravis Roberts & Co. to buoy the drooping value of its 49% in the company, which it took over in the 1989 LBO. Why? "So they and their investment partners can cash out," says Donald W. Mitchell, head of the Waltham (Mass.) consulting firm Mitchell & Co., which tracks the company. KKR insists it is a long-term player and rejects suggestions that it will sell any RJR holdings.
But KKR will reap big rewards when RJR's debt paydown allows the company to start paying dividends. The partnership's yearly haul: $244 million. That's motivation enough for KKR, certainly, but no guarantee that the spinoff will work for everyone else.
THE NEW CORPORATE FISSION Increasingly, companies are turning to stock spinoffs as a recovery strategy. Here are some of the biggest deals in the works: IBM Lagging mainframe sales obscure strength in other areas. So the computer giant is looking to peddle separate stocks for its personal-computer unit, printer group, and other businesses. RALSTON PURINA Last fall, it yanked a plan to spin off 100% of Continental Baking, a longtime earnings drag, due to cost of untangling loan agreements. Now, shareholders will get 55% of the unit. RJR NABISCO Plans separate stock for tobacco and food divisions this spring. Reason: Its stock is drooping amid worries that new taxes and possible legal woes will clobber the tobacco arm's earnings. SEARS ROEBUCK The troubled retailer later this year will sell 20% of Allstate Insurance, hit hard by Hurricane Andrew. It has also divested part of its Dean Witter brokerage and Discover credit-card unit. DATA: COMPANY REPORTS, BUSINESS WEEK