Asset StrippingExplained & Defined
What is Asset Stripping?
Asset stripping refers to a process in which a company or investor purchases an undervalued company for the purpose of selling its assets at a profit.
The purpose of this is that when sold individually, these assets may net a higher return than would be gained by selling the company as a whole.
Shareholders may gain dividend payments from the process, but the company may become less viable as a result.
How Asset Stripping Works
Asset stripping is associated with “corporate raiders” who will purchase a company that is undervalued.
The purchasing company does this with the intent of taking the purchased company’s individual assets such as, for example, its brand name, manufacturing equipment, and facilities.
The purchaser will typically take the purchased company’s liquid assets and distribute the resulting returns as dividends.
Doing this could require the purchaser to take the company private.
Once the purchased company’s assets are sold, it will often be left without operating assets that would be necessary in order to continue normal operations.
In order to continue, the purchasing company may recapitalize the company with debt funding.
Because the company has been stripped of most of its assets, it will likely not have the collateral to issue debt and will instead need to borrow money generally at unfavorable terms through leveraged loans.
These will often be made by one or more banks that will subsequently sell the loan in order to reduce the risk.
These may be sold to mutual funds or securitized into collateralized loan obligations which are bought by institutional investors.
Arguments Against Asset Stripping
Asset stripping often involves selling a company’s operational assets, which may need to be replaced in order to continue to operate.
In addition, it will leave a company with fewer assets to act as collateral for borrowing.
As a result, the asset-stripped company will likely be left financially unstable and may go bankrupt.
Because of this, asset stripping has gained a considerable degree of criticism because of the loss of jobs and the ability of the company to offer value from its operations.
Though in some cases, asset stripping could be used as a technique to raise capital for reducing debt, this is far less common than using it to issue a special dividend to shareholders.
In many cases, the purchasing company will simply default on existing debt instead.
What Conditions Allow Asset Stripping to Occur?
Asset stripping will typically be performed on companies with a strong asset base that can be purchased for less than the book value of its assets.
Undervaluing may occur due to inefficiencies in which the company is not using its assets optimally, poor management depressing the market value or several other reasons.
Poor economic conditions can be a strong contributor because companies will be valued for less than they would be in an ordinary market state.
If a private equity firm or others engaged in corporate raiding find a company that is priced for less than the book value of its assets, then a strong opportunity for asset stripping exists.
Example of Asset Stripping
As an example, consider Company X, which oversees three distinct businesses, including a logistics provider, cruise ship operator, and an automobile retailer.
The company is valued at a total of $130 million, but when sold individually, a group of investors believes that they can sell each of the three businesses and their assets for much more, meaning that there is an opportunity for asset stripping to occur.
The investors estimate that when the brands and their assets are sold, they can make $80 million from the logistics provider, $50 million from the cruise ship operator, and $40 million from the automobile retailer.
Together this would mean total revenue from sales of $170 million and a profit over the market value for the company of $40 million.
This means that the group of investors will attempt to buy the company at its market value and individually sell the brands in order to achieve these profits.
Key Takeaways
- Asset stripping occurs when a company is purchased for the purpose of selling its assets in order to gain a profit.
- Asset stripping is associated with corporate raiders who would perform this practice, particularly through the 1970s-1980s.
- Asset stripping often creates a going concern for the resulting company, which may suffer operational issues due to the loss of assets.