Asset stripping refers to the process of purchasing an undervalued company and then separately selling its assets. The premise of asset stripping is to sell the individual assets of the acquired company at an aggregate higher price than selling the whole company by itself.
How It Works
Asset stripping is commonly conducted by corporate raiders that purchase undervalued companies and attempt to extract value by means of selling individual assets of the acquired company. Examples of individual assets of a company that can be sold include equipment, buildings, brand name, property, etc. To illustrate how asset stripping works, we introduce an analogy below.
Assume that an individual purchases a log of wood for $100. With the acquired log of wood, the individual decides to use his own labor to chop the log of wood into seven smaller pieces. The individual then sells each smaller piece as firewood for $15 each. It is illustrated below:
As such, by chopping the log into smaller pieces and reselling each piece for $15, the individual is able to generate an overall profit of $5 [($15 x 7) – $100]. The same theory applies to asset stripping. An investor (or investors) purchases a company and resells individual assets of the company at a price that, in aggregate, that is higher than the price of the company as a whole.
History of Asset Stripping
Nelson Peltz, Victor Posner, and Carl Icahn were the early proponents of asset stripping during the 1970s and 1980s. Icahn is a prominent figure who performed the notorious takeover of Trans World Airlines (TWA) in 1985. He engaged in asset stripping by subsequently selling the airline company’s assets to settle the debt that was accumulated in purchasing the business.
Opportunities for Asset Stripping
Asset stripping is commonly conducted on undervalued or inefficient companies. Companies whose market value is below its book value are prime targets for asset stripping. It is more likely to occur during poor economic conditions (where companies would be valued lower than they would be in normal economic conditions) or to companies with a poor management team (where a poor management team would depress the company’s market value).
Consequences of Asset Stripping
Companies that have been asset-stripped are left financially unstable and generally face a going concern issue. The practice often draws lots of criticisms in the corporate world, as it results in job losses for employees. Once the assets of a company are stripped (usually those that are pertinent to company operations), the resulting entity is usually void of operating assets that would allow the company to continue operations as normal.
For example, consider a manufacturing company. If the manufacturing company were to be purchased by corporate raiders who then resell its assets (such as equipment, machinery, and buildings), the company would likely face a lack of operating assets to continue operations. As such, the asset-stripped company would face a going concern issue and suffer operational difficulties.
Company A, currently valued at $100 million, oversees two separate businesses. A group of corporate raiders believes that the two distinct businesses of Company A can be sold for $60 million and $70 million, respectively. As such, a corporate raider can purchase the company for $100 and potentially sell both businesses for a total of $130 million – generating a profit of up to $30 million for the seller.
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