If there is a big corporate trend, you can bet that high priced consultants were behind the idea or have since hopped on board offering advice on how to do it better. As spinoffs have become more popular, BCG has penned a number of articles on spinoffs and corporate divestitures. Their
most recent piece notes that although spinoffs have created excess returns (including in the short term), the strategy is cooling off a bit. BCG believes that the conglomerate discount has shrunk and that in the long term, shareholders don’t always punish diversified companies.
So…how should a befuddled executive know if a potential spinoff is a long term value generator? According to BCG, here are the three ‘critical considerations’ he or she should be weighing before pulling the trigger and exciting shareholders:
- Portfolio Logic. Articulating a clear portfolio logic increases a firm’s value beyond the sum of its parts. That logic could include synergy effects, which are a central motivation for keeping multiple activities housed in a single company. If synergies are low or do not materialize as expected, divestment may make good business sense.
- Parenting Strategy. Executives should ask themselves whether the corporate center’s capabilities still fulfill the needs of the individual businesses. A demerger can create value if the needs of each business are highly diverse or if a fast-growing division requires new capabilities that the center cannot provide. Nokia’s sale of its maps business to German car makers was driven by the rationale that the latter would make much better owners. Car makers needed their own maps solution for their autonomous-driving activities and wanted to gain independence from the offerings of Apple and Google.
- Portfolio Balance. If a business is damaging the overall portfolio in the long run by tying up excessive resources and management attention, divesting it can be the right choice. On the other hand, as discussed above, diversification benefits can add a premium to a group’s value. Balanced portfolios ensure long-term value creation beyond short-term profit considerations. General Electric, for example, divested its financial services business to simplify the portfolio and focus it on the company’s core capabilities in premier industrial businesses.
Let those ideas really sink in for a minute…and then think about the cost of getting that advice. Seriously though, I don’t think anyone disagrees, but the line can be very blurry. What one CEO would call a synergistic and value-add, diversifying business, an activist investor might call a non-core distraction. Hard to believe today, but just a few years ago Jamie Dimon was publicly defending JP Morgan’s (JPM) structure from those seeking to break up the bank. He did a good job quantifying the benefits, but it’s not always so easy to do so which is why reasonable parties can disagree.
While there are likely a few bad actors pursuing divestitures with the wrong intentions, I would guess that most CEOs are considering the three above points. Hindsight is what often reveals which spins end up as long term value generators vs. those that don’t.
Disclosure: Author holds no position in any stock mentioned.
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