What is a “Reverse Morris Trust”?

A Reverse Morris Trust transaction is a form of divestiture that combines a spin-off or split-off with a merger. Whilst it is a complicated structure, it is a tax efficient way of divesting a business. It has to be noted that this structure is completed under US tax laws.

A good example transaction is the merger of AT&T’s WarnerMedia with Discovery:

  • Structured as Reverse Morris Trust transaction, AT&T to spin/split out Warner Media which will merge into Discovery
  • Discovery to contribute 100% of its business and receive 29% of common equity
  • AT&T will receive $43B (subject to adjustment) in a combination of cash, debt securities and WarnerMedia’s retention of certain debt
  • AT&T shareholders to receive 71% of common equity distributed via shares of stock

Source: AT&T investor presentation, 17 May, 2021

Key Learning Points

  • Tax-efficient divestiture – Disposing of a subsidiary or assets results in potentially high taxable gains. The Reverse Morris Trust allows a parent company to eliminate any tax and distribute the asset to its current shareholders. Other divestiture alternatives are an outright sale or an IPO of the subsidiary. 
  • Ability to “push down” debt into the spin off subsidiary – As part of the Reverse Morris Trust transaction, the parent often leverages the subsidiary reflecting a normal capital structure and receives a special cash dividend from the debt proceeds (debt “push down”). The parent will normally use the proceeds to repay existing debt.
  • Ability to achieve operating synergies – the merger of the spin-off subsidiary with another operating company can create substantial synergies and thus additional value for the parent shareholders.
  • Conditions to ensure tax free transaction – parent shareholders need to retain at least 50.1% ownership of the merged entity. Often a restrictive covenant will be in place for 2 years, limiting the merged company’s ability to buy back shares.

Reverse Morris Trust Steps

As the graphic above shows, the transaction is complex and will combine the spin-off of the subsidiary and merger with another public company in one single transaction. AT&T’s transaction with Discovery has the following structure:

Reverse Morris Trust (RMT) Rules

In order to achieve and retain the tax free status, certain rules have to be met:

  • The Parent shareholders must own at least 50.1% of the merged entity. This rule normally applies for at least 2 years.
  • In general, SpinCo (the spin off subsidiary) must be bigger than the merger partner to make the relative values work.
  • SpinCo needs to provide 2 years of audited financials which is similar to an IPO.
  • The Parent and SpinCo must have been operating companies for at least 5 years pre the RMT transaction.
  • The Parent and merged entity must continue to operate after the transaction.
  • The Parent must have control (at least 80%) of SpinCo before the transaction.
  • The transaction must have a valid business purpose (as opposed to distributing earnings).

In the case of the AT&T and Discovery deal, the transaction rationale is:

Source: AT&T investor presentation, 17 May, 2021

However, AT&T never really extracted value from the Time Warner acquisition and is saddled with a total of $180bn (March 2021) of debt. The debt push down into SpinCo will provide a welcome reduction in leverage from 3.7x pre transaction to 2.6x EBITDA post closing, allowing for a potential change in dividend policy and share buy backs.