Fall 2022 Midterm Exam on Methods of Gaining Listings- Finance, The University of Utah

Here are some questions and answers asked on the Fall 2022 midterm exam at the university of Utah. This exam was on methods of gaining listings, especially using the spin-off technique. Use the questions included in this blog to get guidance on how to take your finance exams. You can also contact at any time with those complex topics and we will do your exam on methods of gaining listings.

Explain what a spin-off is and the steps involved in gaining a listing through the spin-off method?

Exam Solution: A spin-off is a technique that can only be used in this context by an already listed group.

The steps involved in a spin-off are as follows:

1. Separation

The business or assets which are to be spun off must first be put into a separate subsidiary if they are not already held in this form. This achieves legal separation. However, there may be substantial inter-company borrowings or other financial dealings which must be unwound or put on an arm's length basis. Care must be taken that the company is strong enough financially to survive on its own. Management must also be independent. Transitional arrangements may be needed for such matters as shared computer facilities, insurance and employee benefits.

2. Distribution

The shares of the subsidiary are distributed pro rata to the shareholders of the holding company. The shareholders do not pay any consideration for the shares they receive but may be liable for transfer duty when they are registered in their name. The receipt of the new shares is not likely to be taxed as income in the hands of shareholders. On a subsequent sale, some tax liability is likely to be incurred.

The articles of the holding company may not always provide for this kind of distribution. If they do not, or if the relevant clauses are ambiguous, a shareholders' meeting will be needed. It may be desirable in any case. The distribution, like any dividend, requires sufficient distributable reserves to be available. The number of reserves needed is equal to the book value of the shares to be distributed.

If sufficient reserves are not available or if the distribution would absorb so much of the reserves that future cash dividends would be prejudiced, it is possible to proceed by way of a reduction of capital. This requires a meeting of shareholders and legal confirmation. It is facilitated if the holding company has no creditors or if the creditors can be safeguarded in some way, for example, by a bank guarantee.

It is possible to offer the shares of the subsidiary for purchase by the shareholders of the holding company by way of rights rather than distributing them. This is not a popular method, perhaps because it appears to shareholders that they are being asked to buy something which they already (if indirectly) own.

3. Obtaining a listing

A listing for the company is applied for on the basis that there is already a sufficiently wide spread of shareholders and no separate marketing exercise is required. A company that has been spun off from a larger group will have initially the same shareholders as that already listed group. The spread of shareholders must therefore by definition be adequate to obtain a listing for the shares of the newly spun-off company. This type of listing is said to be obtained via an 'introduction".

Although there may be no sales of shares undertaken, the requirements to provide information to the market must still be fulfilled and a full prospectus document produced.

One of the uncertainties of this type of operation is the price at which the shares will initially trade. As there has been no pricing or underwriting and no previous trading, the price can only be estimated by reference to the financial information published about the company and by comparison with similar listed companies. The group undertaking the spin-off will not normally hazard any indication of the likely price at which trading will commence.

List and explain some advantages of gaining a listing through a spin-off

Exam Solution:

Advantages

1. Rationalization of group structure

A spin-off may be employed by a conglomerate or other group which concludes the part of its business is so different in commercial or financial needs that it should be managed and owned outside the group. Sometimes the technique is used when the financial future of a member of the group is uncertain. A spin-off may be preferable to jeopardizing the group by supporting the company or incurring the odium of having a subsidiary go bankrupt. Rather than the business being sold to an unrelated party, which may in any case be unrealistic at a reasonable price, ownership is transferred to the shareholders of the parent company via a spin-off.

2. Increase in market value

After the spin-off, shareholders will have two distinct investments, one being their original holding and the other a proportionate holding in the newly spun-off company. This gives them greater flexibility and may, by appealing to different investor preferences, increase the combined market value of the two holdings over the market value of the original one. The attractions of the newly spun-off company might have been buried in the complexities or problems of the parent group and so not given full weight, or the company may be in a "glamour' sector and on its own can attract a premium rating from investors who wish to have an investment wholly in that sector. Skeptics might of course query why the company became part of the original group in the first place.

3. Creating a listed vehicle

A spin-off is a useful technique for a group that wants to create a listed vehicle for some specific purpose, such as starting a new line of business or investing in more speculative situations than its normal activities. Instead of buying a shell company, it may create one by setting up a subsidiary, putting some simple assets (perhaps cash, property, or securities) into it, and then distributing the shares to its shareholders. The new company might not otherwise be eligible for a listing or not worth the trouble of a full marketing exercise. The alternative would be to buy a shell company, but the spin-off avoids the need to identify a suitable shell and paying a premium for control.

4. Defense tactic

If a takeover is threatened, a spin-off may be used as a defense tactic to increase the market value of a group, put a 'crown jewel beyond the reach of an aggressor or simply muddy the waters.

What are two other alternative methods of gaining a listing

Exam Solution: Various other methods may be adopted to achieve a sufficiently wide spread of shareholders for a company to be granted a listing via an introduction without any further marketing of shares.

1. Private sales and private placements Well-established businesses may have become public companies and achieved a considerable spread of shareholders through private sales and placements without actually becoming listed. Application for listing may be made subsequently.
2. Share exchange: A new company may be incorporated to take over an existing listed company via a share exchange. This may be desirable if it is not possible to be certain of the financial position of a shell company. Rather than using the shell as the holding company, a new holding company is put on top of the shell. The advantage of this structure is that any assets or businesses to be injected can be controlled by the new holding company rather than by the shell. The financial damage of any claims can then be limited to the shell company and kept isolated from the rest of the new listed group.

Imagination is the only limit to other methods which can be utilized to give a new company the same spread of shareholders as an existing company and on this basis to apply for a listing. Shares in a new company may be offered (usually with a cash alternative) as a minor part of the overall consideration for the shares in a listed company. Liquidators have been approached in effect to transfer the listing of a company in liquidation before it is de-listed in exchange for a payment to creditors plus a distribution to the shareholders of a small percentage of the shares of the new company. This comes close to handing out shares to people in the street to achieve a sufficient number of shareholders.