Since 1979, Gartner Group Inc. has tracked companies on computer technology's cutting edge. With the expected shareholder approval of the IT advisory firm's recapitalization and spin- off of shares owned by IMS Health Inc., though, Gartner itself will vault to the cutting edge--of financial technology.
The spin-off would release Gartner stock from the reluctant grip of its dominant shareholder, and would kick off a novel tax-free disposition of stock that normally would be fully taxable. IMS Health, a consultancy whose main business is keeping tabs on the pharmaceuticals industry, inherited 47 percent of Gartner through a succession of spin-offs going back to the former Dun & Bradstreet Corp.
In 1996, D&B first split its business into three companies, one of which, Cognizant Corp., owned Gartner. Then in 1998, Cognizant split into Nielsen Media Research and IMS Health, with IMS getting Gartner.
When IMS signaled its intent to focus on its lucrative core business, it chilled the value of Gartner shares in a market that feared a possible sell- off. Besides punishing shareholders, the lackluster stock performance hindered the use of stock options as compensation--a devastating penalty.
But devising a separation plan suitable for all parties wasn't easy, in part because of Gartner's very low tax base. Gartner's and IMS's boards rejected making a secondary offering to the public of Gartner shares (threatening to depress stock prices further) and a leveraged purchase of the IMS stake by Gartner insiders (too risky because of the debt involved). Finding a third-party buyer for the stake, directors figured, might spark an unwanted change of control.
Circumstances suggested a tax- free spin-off of Gartner shares to IMS holders. But qualifying tax-free deals requires indisputable proof of control--and, indeed, a super-majority of 80 percent. This hurdle poses tough choices for companies mulling ways to shed investments that are no longer core: Live with them or wake the tax man.
Gartner and IMS settled on an inventive way to satisfy the rules. First came a recapitalization creating two uneven classes of Gartner stock. While holders of both enjoy full economic participation in earnings and dividends, Class B shares bestow the right to elect 80 percent of Gartner's directors, qualifying the spin-off for tax-free treatment.
Handing extra votes to IMS shareholders was justified, says Gartner CFO Michael Fleisher, as long as Gartner shareholders got a fair deal. (A vote this past July 16 by Gartner's non-IMS holders was intended to ensure fairness.) He and other insiders say Gartner holders gave nothing away. "To get the deal done, it seemed like a reasonable price to pay," he says. "This transaction, though complicated, [distributes the shares] in an orderly and tax- efficient way."
One hitch remained: The recap exposed Gartner to hostile bids from predators hungry for the super-voting B shares. The deal team chose a simple but unusual solution. So long as any group acting in concert owns or controls more than 15 percent of B stock, it must own an equivalent Class A percentage. "This is truly novel," says tax expert Robert Willens of Lehman Brothers Inc. "There is nothing about this deal I don't like."
Not every spin-off qualifies to use this tax-free model. To work under IRS regulations, IMS had to own its Gartner stake for more than five years, and needed a stake sufficient to support super-voting privileges. A smaller stake, resulting in greater voting rights, might have raised eyebrows with regulators. But provided those tests are met--and pending legislation doesn't eliminate use of the technique--the structure is usable.
"It's legitimate today," says investment banker Jake Peters, who advised Gartner. Harcourt Inc., in fact, is proceeding with a similar transaction to distribute its minority stake in Neiman Marcus.