Liberty TripAdvisor – Judging the probability of a near-term acquisition
The Liberty TripAdvisor idea was a simple one: LTRPA is trading at a discount to its underlying TRIP shares, despite the fact that LTRPA has a voting right premium that is potentially very valuable.
The question is how and when value will be realized. In order for LTRPA to be worth as much as the underlying shares the company needs to avoid any tax consequences when the company is ultimately sold. If LTRPA sells its TRIP common shares on the open market it would be hit with huge capital gains tax where the tax basis of TRIP shares is only $400 million vs. a minimum value of $2.5 billion – an enormous tax bill. It would also lose its controlling stake in TRIP. It could sell both the common and the high-voting right TRIP shares to a third party, but then again same issue: would still be hit with high capital gains tax.
The only option and the reason why LTRPA was spun off in the first place, is a merger of LTRPA with a third party. Such a merger is tax free under US Internal Revenue Code section 355 as long as it is either a “Reverse Morris Trust” (LTRPA gains over 50% of capital in a merger immediately after the spin off), or if all of the following criteria are met:
1. Parent must “control” at least 80% of the vote of the SpinCo prior to distribution. LTRPA did not appear to satisfy this requirement but Malone managed to get past this requirement in the spin off process.
2. Parent and SpinCo must conduct at least one trade or business after the distribution and have been conducting such trade or business for at least five years prior to the distribution. I believe LTRPA’s smaller segment BuySeason was the reason LTRPA satisfied this requirement.
3. “Device Test”: the distribution must not be used to distribute the earnings and profits of a corporation. This may be tricky to prove for LTRPA.
4. Parent must distribute a minimum “control” of SpinCo.
5. The distribution must be motivated by one or more business purposes
Of course, since the spin off has already taken place the criteria have all been met. But the IRS ruling of LTRPA being a tax free spin off can be invalidated whenever one of the criteria ceases to be satisfied. Specifically, there is a presumption under the device test that if the spun off company is acquired within two years of the spin off date the tax authorities will consider the spin off fully taxable, paid by either the original shareholders or the parent. John Malone knows this and he will of course do everything in his power to avoid this from happening.
If IRS sees LTRPA breaching the device test, the company would have to make a “rebuttal”, a lengthy process where each party argues whether or not being acquired was part of the original plan when they spun off the company. In most cases, the company can successfully argue that the spin off was not a precursor to an acquisition if (the “Safe Harbor I Rule”):
(i) there was no agreement, understanding or arrangement or substantial negotiations concerning the acquisition during the first six months; and
(ii) the spin-off was motivated “in whole or substantial part by a corporate business purpose other than a business purpose to facilitate an acquisition
Greg Maffei has made it clear that is has not been in talks with any third party yet (although he has indicated that Alibaba and TripAdvisor itself could be potential buyers). He mentions it in the following interview from 15:30 to 19:00.
In the S-1, the reason for the spin off was not stated to be a potential acquisition of LTRPA but rather to demonstrate the underlying values in the Liberty Media portfolio in line with the success Malone’s tracking stock. It should be possible to argue that both of these conditions can be satisfied.
If history is any guide, then there has been plenty of acquisitions of subsidiaries recently spun off from their parent companies. In the below sample, all of Ralcorp, Motorola Mobility and Ticketmaster were acquired less than one year after the spin off date with no problem from the IRS.
There have been acquisitions of recently spun off companies within the John Malone sphere. Liberty Media International was merger with UnitedGlobalCom in exactly 1 year after the spin off date. Discovery Holdings was also merged with Advance/Newhouse Communications after the spin off of Ascent Media and that took only 9 months from the transaction until the close of the merger.
Conclusion: it is unclear whether an acquisition of LTRPA within two years after the spin off may cause the tax free status of the spin off to be invalidated. But there have been plenty of examples over the past decades of spun off companies being acquired much earlier than two years, so many that the “device test” might not be such of a big issue anyway. The most likely scenario is that LTRPA will enter into discussions with third parties after six months and that it will somehow be able to demonstrate that an acquisition was not part of the original plan.
I believe there is a fairly large likelihood of a realization of value before the two year period ends. Even if LTRPA is not acquired within two years, then the risk of a fully hedged long LTRPA short TRIP pair trade is so low that it might be worth accepting a lower return on the investment than in a normal long or short position.