Asset Stripping Definition Examples How Does It Work

Asset Stripping Definition

Explanation

Asset Stripping is mostly done on undervalued companies. When an investor sees that a company is undervalued in the market, they try to value the company’s Real Assets in the market. Once the value of the assets is determined, it is seen that the value of the individual assets is worth more than the company as a whole. Then they buy the undervalued company and sell off the assets individually in the market. The cash generated from the sale is distributed as a special dividendSpecial DividendThe term “Special Dividend” refers to an amount distributed to shareholders in the name of a dividend that is in addition to the regular dividend. Companies do this in the event of an unexpected inflow of cash or assets.read more to the shareholders.

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History

Carl Ichan, Victor Posner, and Nelson Peltz were investors in the 1970s to 1980s. They started Asset Stripping as a practice to generate profit. Carl Icahn did aA hostile takeover is a process where a company acquires another company against the will of its management.read more hostile takeoverHostile TakeoverA hostile takeover is a process where a company acquires another company against the will of its management.read more of “Trans World Airlines” in 1985 and sold its assets to pay for the debts of the takeoverTakeoverA takeover is a transaction where the bidder company acquires the target company with or without the management’s mutual agreement. Typically, a larger company expresses an interest to acquire a smaller company. Takeovers are frequent events in the current competitive business world disguised as friendly mergers.read more.

How does Asset Stripping Work?

Step 1: Private Equity firmsPrivate Equity FirmsPrivate equity firms are investment managers who invest in many corporations’ private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP.read more engaged in Asset Stripping practices look for undervalued companies with a strong asset base. Companies can be undervalued due to a lack of good management or other reasons.Step 2: The Private Equity firm looks for a market where it can sell the assets reasonably. Assets can be sold at a higher value when you get a strategic buyer, a person looking for a particular asset to do the production.Step 3: The value of the assets in the market is determined. Then if the value of the assets is more than the company’s value as a whole, the process of acquiring the company begins.Step 4: Most of the acquisition is made by issuing debt. These are called Leveraged BuyoutLeveraged BuyoutLBO (Leveraged Buyout) analysis helps in determining the maximum value that a financial buyer could pay for the target company and the amount of debt that needs to be raised along with financial considerations like the present and future free cash flows of the target company, equity investors required hurdle rates and interest rates, financing structure and banking agreements that lenders require.read more.Step 5: Once the company is bought, the assets are sold to the strategic buyers, and the money generated is used to repay the debt, and the rest is paid to shareholders as a Special Dividend.

Example of Asset Stripping

Company A has five different businesses. Due to the current poor economic scenario caused by COVID-19, the company is trading below its Book Value. A private equity firm, which is engaged in Asset Stripping, starts to evaluate the company’s businesses. He found that the company’s worth now is $400M, but each business separately can be sold at $150M once the COVID-19 fear gets over. So the private equity firm acquired the undervalued company at $400M.

Solution

When the COVID-19 is over and the market recovers, the Private equity firm will sell individual businesses at $150M each.

Total selling price = $150M * 5 (As there are five businesses and each can be sold @$150

= $750M

Profit = Selling Price – Buying Price

= $750M – $400M= $ 350

Percentage of Profit = (Profit / Initial Investment) * 100

= (350 / 400) * 100= 87.5%

So private equity firms make huge profits through Asset Stripping. The main challenge is to find the potential buyer for the assets. Private equity firms are engaged in this kind of business for the long term, so they have contacts worldwide, and it is easier for them to sell assets at a reasonable price.

Opportunities

Most Private Equity firms are engaged in Asset Stripping; they are continually looking for targets. Not all companies in the market are efficiently managed. Some companies are managed inefficiently. That is, the assets are not put to optimal usage. When a particular company is not managing assets properly, they trade below their book value. In severe economic conditions like COVID-19, companies tend to be severely undervalued, which is the perfect asset-stripping opportunity. Undervalued companies will be bought and sold part-wise for greater profit when the economic condition improves.

Implications

When asset Stripping is done, mostly the assets with economic value are sold. So if a company loses its economic assets, it makes the company weaker as it loses its assets, so it gets difficult for the company to raise more debts via collateral. The company gets weakened, so the debt charges increase as the company is prone to bankruptcy now.

Criticism

Asset Stripping breaks a company into several parts, thus creating unemployment. Employees lose their jobs once the parts are sold to different buyers.It is a loss for the economy as the company could have turned with proper management and with the change in the economy, but it loses its value and slowly reaches bankruptcy due to asset-stripping.

Advantages

Shareholders who were suffering due to low share prices get their money back in a special dividend.Asset stripping is a threat to improperly managed companies. So managers tend to utilize the assets efficiently and manage companies optimally to save themselves from such situations.

Conclusion

Asset Stripping nowadays is mostly being performed by Private equity firms. It is a good way of generating profit for the investors, but it destroys the target. So in many countries, government regulations must be followed before applying such strategies.