Demergers – When 2 and 2 can often make 5

While there has recently been a dearth of major M&A activity with most large companies apparently lacking the confidence to take the plunge into lumpy acquisitions, this has conversely been mirrored by a noticeable upturn in the number of demergers.

Cable & Wireless, Carphone Warehouse and Petrofac are all examples of substantial public companies which have “done the splits” in the last 2 or 3 years. These demergers were primarily designed to enhance shareholder value by making each component easier for investment analysts to rate and by giving existing management teams full rein to express themselves and grow their own units without having to keep deferring to their superiors.

In the case of Carphone Warehouse which demerged its Talk Talk broadband arm and Petrofac which floated off its North Sea oil producer, Enquest, the demergers have both been resounding successes with the market value of all four units now being well in excess of the combined value of the original two entities.

The value of such demergers can be optimised with careful preparation on the part of tax accountants and advisers. For example, a new parent company inserted into the pre-demerger corporate structure can be used to prevent a liability to a chargeable gain on the transfer of the assets being demerged.

Secondly, stamp duty relief within a demerger transaction should be achievable provided a proportional mirror before and after the demerger can be demonstrated. Furthermore, value can be released to shareholders by creating a merger reserve and using it as part of the demerger.

By way of example, a merger reserve can be established when a new parent company (New Parent) is placed over the top of the group and new shares in the parent company are issued to New Parent in consideration for the issue of two new classes of shares to the holders of shares in New Parent.

Provided the two new classes of share are issued at a low nominal value, the difference between the market value of the shares issued to New Parent and the nominal value of the two new classes of share can, as a result of the 2006 Companies Act, section 612, be posted to a merger reserve.

There is little doubt that sound tax advice coupled with tax legislation as it now stands affords the opportunity to make demergers even more attractive as a way to unlock shareholder value in an environment in which many CEOs see the stock market value of their companies remain stubbornly below their intrinsic worth.

Osborne Clarke are an international law firm specializing in mergers and acquisition law

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