2021: The year of the Merger (And the Spinoff)
While record-breaking M&A activity has dominated headlines, it has also been a big year for spinoffs, especially among some of the largest corporations. Major spin-off stories this year include:
- GE’s announced spinoff into three distinct companies, focused on aviation, energy and healthcare technologies.
- Harley-Davidson’s spinoff of its high-growth EV segment.
- Johnson and Johnson’s split into two companies: one for consumer products and the other for medical technology.
- AT&T’s likely spinoff of its entertainment segment, creating Warner Bros Discovery.
- Toshiba’s announced split into three companies, with its energy infrastructure and computer device businesses spinning off from the main company.
This spike in activity has market watchers wondering why, and many asking what exactly a spinoff means for the resulting companies and their shareholders.
Often used interchangeably, spinoffs, demergers and divestitures are easy to conflate. In simple terms, a spinoff makes a new independent company out of a piece of the old one. Demergers are similar, but the piece of the company is generally sold in whole to another firm. Divestitures sell off parts of the company to the highest bidder(s).
Spinoffs are unique in that the same shareholders usually own both the old and new company immediately following the split. The shareholders in the parent company receive stock in the spun-off company to compensate their lost equity in the old firm. After the split, shares in both companies can be traded freely.
As a quick example, if a $100 million company, creatively called Company A, spun off a business segment worth $10 million to create a new Company B, Company A would now theoretically be worth $90 million. Company A’s shareholders would collectively receive $10 million worth of shares in Company B, proportionate to their stake in Company A.
From that point on, both Company A and B can have their shares freely traded independent of one another, assuming they’re both public.
Why are Companies Spinning off?
While antitrust concerns are a potential reason for spinoffs, the two most likely reasons for this year’s biggest spinoffs are: creating more value for shareholders in an aging bull market, as well as staying lean, agile and competitive in a changing economy.
Staying on the Bull: Stretching Shareholder Value
As a bull market matures, corporations have to get creative about how to keep creating value for their shareholders. History shows us that large corporations tend to pursue spinoffs in the latter stages of a bull market, when valuations are peaking, as a way to maximize short-term returns for shareholders and create a new catalyst for value.
Increased spinoff activity is often a side effect of a highly valued market. Risky assets across the board are valued near or at all-time highs, leading some economists to call the current capital environment an “everything bubble”. As valuations are pushed to their rational limit, boardrooms and executives have to get creative about creating value for shareholders. One reliable way to do this is through spinoffs. A spinoff allows a smaller, high-growth segment to be valued more highly, ideally generating better returns for investors and giving them the power to invest more heavily in that specific segment.
HBO Max’s perceived undervaluation was a major spinoff driver
In AT&T’s spinoff of its media holdings into WarnerMedia-Discovery, CEO John Stankey cited HBO Max’s potential growth and relatively low valuation as a reason for the move. He expects that separating the company’s media holdings, which include streaming service HBO Max, will cause the market to value WarnerMedia-Discover more closely to streaming powerhouses like Netflix, rather than a maturing cable company.
Strategic Focus & Agility: Avoiding “Anti-Synergy”
As we discussed in our article on M&A synergy, companies do best when a subsidiary or business segment in some way complements the core business. If not, different segments of the company may develop diverging interests and objectives, causing the company to lose strategic focus.
Segments that are too different from the core business often make poor M&A targets and great candidates for spinoffs, particularly when enjoying high growth. The need to focus a company becomes greater in times like ours, when the world is changing with dizzying speed and innovation makes or breaks a company.
One of the year’s best examples of a spin-off to help maintain strategic focus has been Harley-Davidson’s release of its EV motorcycle line-up, LiveWire. The company will retain partial ownership interest in the company and provide financial backing, but will free the new firm to make key decisions independent of the larger company structure. As the CEO said in announcing the spinoff, "LiveWire will be able to operate as an agile and innovative public company while benefiting from the at-scale manufacturing and distribution capabilities of its strategic partners, Harley-Davidson & KYMCO".
Flagship Firms Falling Behind
The world is passing through one of the fastest economic restructuring events in history, driven primarily by the integration of the computer in all facets of life. Corporations are not immune to this change, and are finding that fortune favors the nimble when the ground starts shaking. Large firms enjoy more market power and greater scale, but a big ship is slower to turn. Companies historically face a tension between getting big and getting bloated, and this tradeoff is highlighted when industry trends see a dramatic shift as they have in the past few years.
This creates an impetus for spinoffs, especially in young industries that require agility and laser-like focus. In 2021, GE and Toshiba are two huge companies that are likely spinning off to stay ahead amid flagging stock performance. Both companies saw some positive price movement following their spin-off plans.
As Toshiba CEO Satoshia Tsunakawa said, “[the spinoff] will unlock immense value by removing complexity, it enables the businesses to have much more focused management, facilitating agile decision-making, and the separation naturally enhances choices for shareholders.”
Though their performance in recent years has been stronger, the need for greater focus was a major driver for both AT&T and Johnson and Johnson’s recent spinoffs as well.
Virtual Data Rooms: One Less Problem
Spin-offs can be an exciting tool for creating more shareholder value and unlocking the potential of both companies, old and new. However, anyone who’s been on the front lines of a spin-off knows one thing: the process itself can be a major headache. Audits, due diligence, and lots of data transfers are a guarantee.
During any corporate reorganization, sensitive data will be shared among a diverse group of parties, including internal leadership, outside legal teams, and auditors. Intellectual property, legal agreements, and performance reports need to pass between entities. Additionally, auditors will likely require access to large swaths of internal data during the spinoff. Sending documents and other files each time someone requests them is not only cumbersome, but can also introduce multiple points of security failure.
Corporate reorganizations create both the risk of unauthorized access and the opportunity to step up how your company stores, shares, and manages files. A virtual data room vastly increases the security of your documents, and gives you complete control over who has access, how much access they have, and for how long.
Start your free trial of SecureDocs today to see how easy it is to get your data room up and running.