Asset Stripping

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.

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.