Asset Stripping

Asset Stripping

Asset stripping is the process of buying an undervalued company with the intent of selling off its assets to generate a profit for shareholders. If the value of the company is currently $100 million but another company believes that it can sell each of its three businesses, their brands, and real estate holdings to other companies for $50 million each, an asset-stripping opportunity exists. Asset stripping is when a company or investor buys a company with the goal of selling off its assets to make a profit. Asset stripping weakens a company, which has less collateral for borrowing and may have its value-producing assets stripped out, leaving it less able to support the debt it has. The individual assets of the company, such as its equipment, real estate, brands, or intellectual property, may be more valuable than the company as a whole due to such factors as poor management or poor economic conditions.

Asset stripping is when a company or investor buys a company with the goal of selling off its assets to make a profit.

What Is Asset Stripping?

Asset stripping is the process of buying an undervalued company with the intent of selling off its assets to generate a profit for shareholders. The individual assets of the company, such as its equipment, real estate, brands, or intellectual property, may be more valuable than the company as a whole due to such factors as poor management or poor economic conditions.

The result of asset stripping is often a dividend payment for investors and either a less-viable company or bankruptcy.

Asset stripping is when a company or investor buys a company with the goal of selling off its assets to make a profit.
Asset stripping often yields a dividend payment for shareholders while simultaneously resulting in a less-viable company.
Recapitalization refers to the process where asset-stripped companies take on new debt often through the use of leveraged loans.

Understanding Asset Stripping

Asset stripping is an action often engaged in by corporate raiders, whose method is to buy undervalued companies and extract value out of them. This practice was especially popular in the 1970s and 1980s and can still be seen in some of the investment activity by private equity firms today.

Private equity firms will acquire a company, sell off its most liquid assets, and raid its cash coffers to pay dividends to itself and shareholders. Such activity may involve taking a company private. The private equity investor will then recapitalize the company with additional debt, which gives the practice its euphemistic name "recapitalization," which is a rebranding of the stigmatized asset-stripping practice.

Recapitalizations often involve the use of leveraged loans. Such a strategy is necessitated by the fact that stripped-out companies may have little collateral left to issue debt and must instead borrow money, usually at less favorable terms and rates. The leveraged loans are often made by a group of banks that see them as too risky to keep on their balance sheets.

As a result, the structured products are quickly sold off to mutual funds or exchange traded funds (ETFs). They may also be securitized into collateralized loan obligations (CLOs), which are bought by institutional investors.

Criticism of Asset Stripping

Asset stripping weakens a company, which has less collateral for borrowing and may have its value-producing assets stripped out, leaving it less able to support the debt it has. Generally, the result is a less viable company, both financially and in its potential to create value by way of manufacturing or another enterprise.

While proceeds from asset stripping may be used to pay down debt, it is far more common that proceeds will be utilized to pay a dividend to shareholders. For example, retailers that are owned by private equity companies that have engaged in asset stripping and recapitalization are more likely to default on their debt.

Investors that engage in asset stripping argue that it is their right to do so and that they are extracting value out of companies that are destined to fail.

Example of Asset Stripping

Imagine that a company has three distinct businesses: trucking, golf clubs, and clothing. If the value of the company is currently $100 million but another company believes that it can sell each of its three businesses, their brands, and real estate holdings to other companies for $50 million each, an asset-stripping opportunity exists. The purchasing company, such as a private equity firm, will then buy the company for $100 million and sell each business off separately, potentially making a $50 million profit.

Related terms:

Accounting

Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more

Asset Stripper

An asset stripper purchases a company and intends to divide the corporation up into its parts and sell them for profit. read more

Buy, Strip And Flip

A buy, strip and flip occurs when a private equity firm buys a company, guts and restructures it, and then sells it on in an IPO shortly after. read more

Collateralized Loan Obligation (CLO)

Collateralized loan obligations (CLO) are securities backed by a pool of debt, usually loans to corporations with low credit ratings or private equity firms. read more

Corporate Raider

A corporate raider is an investor who buys a large number of shares in a corporation to gain significant voting rights and push for changes. read more

Default

A default happens when a borrower fails to repay a portion or all of a debt, including interest or principal. read more

Dividend

A dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors. read more

Equity : Formula, Calculation, & Examples

Equity typically refers to shareholders' equity, which represents the residual value to shareholders after debts and liabilities have been settled. read more

Leveraged Loan

A leveraged loan is a type of loan that is extended to companies or individuals that already have considerable amounts of debt and/or a poor credit history. read more

Leveraged Recapitalization

Leveraged recapitalizations replace most of a company's equity with debt, often as a takeover defense. They consists of both senior bank debt and subordinated debt. read more