Naked or otherwise, Wall Street executives are not usually known from their prowess at playing Twister — but boy, can they spin. And these days they’re not to be outdone, not even by the savviest spin doctor in their PR department.
That’s because no spokesperson knows how to do this kind of spin, for it takes place at the highest level of leadership. It’s the corporate spinoff: where a business entity, known as the parent, cuts loose a division and makes it independent. But once a spinoff sets in motion — and one company becomes two or more — it can take investors on a ride that’s either thrilling or more chilling that a Tilt-A-Whirl run amok.
The Ernst & Young Global Corporate Divestment Study offers one major metric that puts the spinoff phenomenon in perspective. Nearly one in two companies surveyed — 49 percent — indicate they plan to make a divestment within the next two years.
“Spinoffs can be tremendously rewarding for both ‘RemainCo’ and ‘SpinCo,'” says Paul Hammes, EY’s global divestiture services leader, referring to the parent company and the newly created entity. “EY analysis finds that SpinCos outperform the [Standard & Poor’s] 500 index by 19 percent over the two years post-close.”
Nor is this a low-profile proposition. Stuart Cable, a partner and chairman for Goodwin Procter’s merger and acquisition and corporate finance group, cites two major examples from the tech sector last year. In July, PayPal Holdings (ticker: PYPL) separated from eBay (EBAY), while HP (HPQ) spun off the Hewlett Packard Enterprise Co. (HPE) in November.
“The uptick in announced spinoffs in 2015 was largely precipitated by the increasing focus of the [shareholder] activist community on pure play,” Cable says. “Specifically, the activist often asserts that business A and business B are worth more apart than together.”
And shareholders have clear reasons for pressing such an agenda. “By splitting up the businesses, they believe, the company will be able to unlock value for shareholders,” says Christopher J. Hewitt, a partner at the Tucker Ellis law firm and based in Cleveland. “This is the primary reward of a spinoff: increased total value from the same assets being owned separately.”
To an extent, the numbers back this up. A 2015 report by the Edge Consulting Group and Deloitte found that 60 percent of global spinoffs in past two decades significantly outperformed every global benchmark index in the first and second year of listing.
Sounds tempting, right? Yet is it always wise, to borrow from candy aisle parlance, to pry apart the peanut butter from the chocolate? That depends — and hungry investors looking for immediate returns might be best advised to hang in there for the longer term, or hang it up.
Consider Hewlett Packard Enterprise, which is down 24 percent since spinning off. Over the same span, HPQ is down almost 30 percent. Citing EY research, Hammes notes that of 46 spinoffs, 18 actually underperformed. “Many organizations have come to learn you can’t ‘just spin it.'”
That lesson may not hit home for some until the deal is done. Big spinoffs set for this year include Citrix Systems (CTXS) jettisoning GoTo Products, and Yahoo (YHOO) casting off its core Internet business after scrapping its effort to sell its stake in the Chinese e-commerce giant Alibaba Group Holding (BABA) in December.
In Yahoo’s case, it remains to be seen exactly how the spinoff will be structured and to what extent it can help the company’s flagging share price. On the one hand, Yahoo stock tumbled on a consistently downward slope, down more than a third in 2015. Yet 17 of 29 analysts rate Yahoo a “strong buy,” with not a single one opting for “underperform” or “sell.”
Spinoff talk could be in part responsible. “But merely spinning off unattractive units is not adequate for reigniting growth,” says Phyllis Ezop, a strategic consultant and president of Ezop and Associates in suburban Chicago. “Even after shedding a major unit, the company still has to determine how to grow.”
“If a company lacks the necessary infrastructure, capital or liquidity to survive as a standalone entity, its failure may be easy to presage,” says Laurence M. Smith, chair of the corporate and securities group of Chiesa Shahinian & Giantomasi.
So how is a profitable outcome achievable for parents, spinoffs and investors? Experts point to issues of focus: First, the spinoff company needs to show that it’s working a market sector unrelated to the parent. Enter the ever-popular “pure play,” which refers to the freed spinoff sticking to the one thing it does best.
Second, a parent has to reassure Wall Street and ratings agencies that spinning off a division gives it more agility to pursue its core business. Make no mistake, it takes heavy lifting to make a win-win-win possible.
“Big rewards come with big risks,” says Steve Sapletal, a director in the Minneapolis Office of West Monroe Partners. “Why is this? The parent that’s spinning off a business unit, or just splitting the company, often underestimates the amount of work it takes. What you don’t read about is the time and cost to separate the financial systems, IT platforms and applications.”
Key vendor contracts also need to be split and by the way, there’s that one other resource: “Most importantly,” Sapletal says, “it’s the people.” As in: Which company gets the A-list talent? Who gets let go and who gets to stay? And who gets to run the spinoff as it tests the Wall Street waters for the first time?
As you might expect, there’s no time for the new spinoff to sail in circles — not when there are activist shareholders watching every move. And so, experts caution investors to watch which way the marketplace winds blow.
“Spinoffs that work well usually do so because they hold a distinct competitive advantage, having proven a concept with their parents’ strong balance sheets,” says Scott Cockerham, CEO and a managing director of Conway MacKenzie Capital Advisors. “And those that are ancillary service lines moving into a competitive field may be exposed upon achieving independence.”
Or as Sapletal sums it up: “Did the new company get dumped with the trash — the leftover business that the parent did not want, employees that are not the highest performers? There are things that have to be evaluated before one declares victory.”
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Corporate Spinoffs: Tops or Topsy-Turvy? originally appeared on usnews.com
