Meredith Media to Separate and Sell Its Divisions in Transactions that Are Taxable to Shareholders

By Stuart E. Leblang, Michael J. Kliegman  and Amy S. Elliott

Meredith Corporation (NYSE:  MDP) (Meredith)—a multi-platform media conglomerate that is associated with such brands as PEOPLE, Better Homes & Gardens, Southern Living and REAL SIMPLE—announced back in May^[1]that it had decided to separate its Local Media Group from its National Media Group, selling the former to Gray Television, Inc. (NYSE:  GTN) (Gray) for an enterprise value of $2.7 billion in cash (later revised to $2.825 billion, increasing the amount of cash Meredith shareholders would receive from $14.51 per share to $16.99 per share^[2]) and placing National Media Group in a separate publicly traded company (Spinco) that it would spin out to shareholders in a taxable transaction, expected to close in the fourth quarter of 2021.^[3]

Then on October 6, Meredith announced that it had agreed to sell Spinco (technically Meredith Holdings Corporation, which will contain its National Media Group businesses) to About Inc. (Dotdash), a subsidiary of IAC/InterActiveCorp (NASDAQ:  IAC) (IAC), in an all-cash transaction at $42.18 per share also expected to close by the end of this year.^[4]

As it stands, Meredith shareholders are expected to receive $16.99 per share in cash in connection with the Gray sale/merger and an additional $42.18 per share in cash in connection with the Dotdash sale/merger.  While shareholders are not required to vote on the Dotdash merger, Meredith shareholders do need to vote to approve the Gray merger (at a special shareholder meeting, the date of which has yet to be announced).

Taxable Spin-Off

The overall structure of the transaction makes sense from the standpoint of minimizing corporate tax while separating the company into its two components and selling at least one of them.  It appears that the company has a relatively high tax basis in the National Media Group, allowing flexibility to leverage the Spinco and reduce leverage on the parent company without triggering taxable gain.  Distributing a National Media Spinco in a taxable spin-off (discussed below) was apparently expected to result in little or no taxable gain based on the numbers.^[5]

Given the prearranged disposition of Spinco in the Gray merger, the spin-off would be rendered taxable at the corporate level under the anti-Morris Trust rules of Internal Revenue Code (IRC) Section 355(e), which generally apply gain recognition to a tax-free spin-off that occurs as part of a plan under which the Remainco shareholders do not retain more than 50 percent of both Spinco and Remainco.  However, because Meredith has little to no gain with respect to the Spinco assets (Meredith has a “high tax basis” in National Media Group^[6]), the transaction is being characterized as “tax efficient” at the corporate level.^[7]

In fact, the spin-off will be disqualified from tax-free status altogether under the rules of Section 355, as a result of the prearranged cash sale of 100 percent of Spinco in the Gray merger, a conclusion stated by the company in the preliminary proxy filed August 17.^[8] The prearranged taxable sale runs afoul of two separate requirements under Section 355—device and continuity of interest.  First, the statute requires that the distribution not be “used principally as a device for the distribution of . . . earnings and profits [E&P] . . . .”^[9] Without defining the term, the regulations indicate that a post-spin sale negotiated or agreed upon before the distribution is substantial evidence of a device.^[10]

Continuity of interest requires that the shareholders of the distributing corporation have a significant continuing interest in both the Remainco and Spinco following a spin-off.  While this seems similar to the anti-Morris Trust rule of Section 355(e), there are principally three relevant differences.  First, continuity of interest would not be violated by a subsequent tax-free merger with a larger acquiring company (e.g., the classic Morris Trust transaction).  Second, sufficient continuity could be maintained with a sale of more than 50 percent of the post-spin stock.  Third, and most important here, violation of the continuity requirement disqualifies the transaction from tax-free treatment for both the corporation and the shareholders.  In this case, because all Remainco shareholders will exchange their shares for cash immediately after the spin-off, the transaction does not satisfy the continuity of interest requirement and the spin-off will be taxable to shareholders.

For these reasons, Meredith shareholders should expect the distribution of Spinco stock to be treated as a taxable dividend to the extent of their share of Meredith’s current and accumulated E&P (with the excess treated as non-taxable return of capital to the extent of their tax basis and then capital gain).  To get a fairly imperfect sense of the size of the dividend in this case, we can look at Meredith’s June 30, 2021 retained earnings figure as a proxy for E&P ($506.3 million).^[11]The actual figures as to the amount treated as a dividend should be provided to shareholders early in 2022.  Importantly, foreign Meredith shareholders will generally be subject to 30 percent withholding tax on the dividend portion (subject to a lower rate by treaty), but given the inherent uncertainty as to the amount treated as a dividend, it is likely that prime brokers will want to treat the entire value of the distributed stock as a dividend subject to withholding tax.

As in other similar situations on which we have commented, Meredith could have fairly easily arranged for the taxable spin-off to avoid withholding tax to foreign shareholders but coupling it with a reduction in each shareholder’s shares (e.g., by adding a reverse stock split), bringing it within the redemption rules of Section 302.  As such, in view of the prearranged sale of the distributing corporation to Gray, the redemption, while pro rata, would clearly qualify as a capital gain transaction pursuant to the well-established Zenz doctrine, with no further action required on the part of the shareholders.^[12] Not only would this benefit foreign investors, it would avoid the necessity of engaging in an E&P study.

Sale/Merger of Spinco to Dotdash

As stated above, there is now an announced deal for Spinco to be purchased by Dotdash following the distribution and expected to close by year-end.  The Dotdash merger is effectively an all-cash merger that will be taxable to Spinco shareholders.  However, it is interesting to note that if the Dotdash merger is completed on the same day as the spin-off and Gray merger, then some of the Meredith debt payoff could be funded through funds advanced by Dotdash.^[13] Looking at the transactions now, it seems that Meredith could avoid the spin-off altogether, sell the National Media Group to Dotdash and then complete the Gray merger.  In this case, the corporate level tax consequences to Meredith would be the same, but they could dispense with the taxable dividend spin-off.  As to why they have not changed their approach, we assume it is because of the timing of the respective transactions with Gray and Dotdash.

Other Structuring Options

Meredith apparently was presented with other offers from buyers presenting different transaction structures.  According to the preliminary proxy, on March 11, 2021, Meredith received a written non-binding letter of interest from a potential acquiror that was interested in a Reverse Morris Trust transaction whereby Meredith would instead put its Local Media Group business in Spinco before merging Spinco with the acquiror (where corporate tax under Section 355(e) would be avoided because Meredith shareholders would end up with 50.7 percent of the combined company, such that Meredith shareholders would only be taxed on the cash dividend received and not on the distribution of the Spinco shares).  But apparently, that deal would have resulted in a more highly leveraged company and would have “introduced a higher degree of complexity,” so was ultimately abandoned.^[14]

Finally, we come back to the fact that, as the transaction is structured, Meredith shareholders will be taxed on receipt of a dividend of what may be as much as $42.18 per share (the amount of consideration Dotdash will pay for the Spinco stock) in the context of what amounts to a sale of the entire company.  This will result in withholding tax to foreign investors, and, as far as we can tell, there is no different constituency among the shareholders that would benefit from dividend (rather than capital gain) treatment.  Ideally, the distribution of Spinco could be avoided entirely and the Dotdash transaction could be structured as a direct sale occurring prior to consummation of the Gray merger.  But we recognize that this would likely require an amendment to the Gray merger agreement and delaying the Gray transaction closing until after the Dotdash sale is consummated.

However, even ignoring the sale of National Media Group to Dotdash, the pre-Gray sale distribution of National Media Group could be structured as a redemption of shares using one or another available techniques, bringing the distribution within the redemption rules and qualifying the distribution automatically as capital gain under the Zenz rules referred to above.  One example of where this was done was the pre-merger distribution of shares in New Fox in connection with the 2019 merger of Twenty-First Century Fox, Inc. and The Walt Disney Co. (redemption effected via internal merger).^[15] Another is the 2018 distribution by La Quinta Holdings Inc. of its real estate holdings in a new REIT, CorePoint Lodging Inc., in conjunction with the acquisition of La Quinta by Wyndham Worldwide Corp. (redemption effected via reverse stock split).^[16] It may not be too late for Meredith to make this change in the mechanics of its pre-Gray merger distribution of National Media Group so as to avoid the prohibitive cost of withholding tax to foreign investors as well as the administrative issues associated with it.

^{[1] Press Release, Meredith, Meredith Corporation to Sell Local Media Group for $2.7 Billion, Focus Exclusively on Leading Portfolio of National Brands (May 3, 2021) (https://www.sec.gov/Archives/edgar/data/65011/000119312521146844/d361418dex991.htm).}

^{[2] Press Release, Meredith, Meredith Corporation Accepts Revised Proposal from Gray Television to Acquire Local Media Group (June 3, 2021) (https://www.sec.gov/Archives/edgar/data/65011/000119312521180612/d105994dex991.htm).}

^{[3] “No corporate-level tax for spin-off expected due to tax basis in NMG business (including Time Inc.) . . . Shares and cash merger consideration received by shareholders will be taxable,” Investor Presentation, Meredith, Transforming Meredith Corporation for future growth (May 3, 2021) (https://s21.q4cdn.com/842953260/files/doc_presentations/2021/5/Transforming-Meredith-for-Future-Growth-Investor-Presentation-(FINAL).pdf).}

^{[4] Press Release, Meredith, IAC’s Dotdash to Acquire Meredith Corporation’s National Media Group (Oct. 6, 2021) (https://meredith.mediaroom.com/news-releases?item=137620).}

^{[5] Supra, note 3.}

^{[6] In 2018, Meredith purchased Time Inc. for $2.8 billion ($1.85 billion in cash plus the assumption of debt).}

^{[7] https://s21.q4cdn.com/842953260/files/doc_presentations/2021/5/Transforming-Meredith-for-Future-Growth-Investor-Presentation-(FINAL).pdf}

^{[8] “The distribution by Meredith of the shares of NMG SpinCo Capital Stock will not be eligible for treatment as a tax-free distribution,” Preliminary proxy statement, MEREDITH (Aug. 17, 2021) (https://www.sec.gov/Archives/edgar/data/0000065011/000119312521248170/d379619dprem14a.htm)}

^{[9] IRC §355(a)(1)(B).}

^{[10] Treas. Reg. §1.355-2(d)(2)(iii).}

^{[11] https://www.sec.gov/ix?doc=/Archives/edgar/data/65011/000006501121000079/mdp-20210630.htm}

^{[12] See Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954).}

^{[13] https://www.sec.gov/ix?doc=/Archives/edgar/data/65011/000119312521293654/d200314d8k.htm}

^{[14] Supra, note 8.}

^{[15] We wrote several reports on the transaction, the most relevant being “Addressing Withholding Tax Concerns in Revised Disney-Fox Deal” (June 22, 2018).}

^{[16] See our report “La Quinta Pre-Merger Distribution of CorePoint Now More Favorably Structured for Foreign Investors” (March 30, 2018).}