Stock Spinoffs and How It Can Unlock Value

A spinoff, also known as spinout or starbust, is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company. Companies that are spun-off are usually expected to be worth more as independent entities than as parts of a larger business.

When a corporation spins off a business unit that has its own management structure, it sets it up as an independent company under a renamed business entity. The company that initiates the spinoff is referred to as the parent company. A spinoff retains its assets, employees, and intellectual property from the parent company, which gives it support in a number of ways, such as investing equity in the newly formed firm and providing legal, technology or financial services.

A spinoff may occur for various reasons such as better management of resources and divisions that have more long-term potential. Businesses that wish to streamline their operations often sell less productive or unrelated subsidiary businesses as spinoffs. For example, a company might spin off one of its mature business units that is experiencing little or no growth so it can focus on a product or service with higher growth prospects.

According to Investopedia, a corporation can create a spinoff by distributing 100% of its ownership interest in that business unit as a stock dividend to existing shareholders or offer existing shareholders a discount to exchange their shares in the parent company for shares of the spinoff. For instance, an investor could exchange $100 of the parent’s stock for $110 of the spinoff’s stock. Spinoffs tend to increase returns for shareholders because the newly independent companies can better focus on their specific products or services.

Statements have been made about a valuation discount embedded into companies with multiple businesses. The argument is that a separation or spinning-off of businesses will help companies unlock this discount thereby increasing their value to shareholders. A research by PwC shows that although spin-offs can be an attractive move for some companies, they do not automatically unlock value. The success of a spin lies in how the spun-off entity and the parent company are able to improve their execution as stand-alone entities.

How spinoffs can be used to unlock Value

The value creation from a spin-off lies in how the spun-off company and the parent company are able to improve their execution as stand-alone entities. Large companies often dictate homogeneous action plans to all their businesses that may benefit some of them but can actually harm others. A successful spin-off is one in which the transaction unshackles the new independent business from those corporate mandates enabling it to operate more efficiently. Some of the changes spun-off entities can enjoy are more focused management, attract better talent, eliminate conflicts of interests, improve capital allocation and drive a clear and cohesive strategy.

Two steps that can be employed to unlock value

The two steps discussed below have been employed by PricewaterhouseCoopers and has produced valid results.

·      Define spin-off strategy through a value lens.

In this step, it is essential to first understand how the different business segments within an organization contribute to overall value. The Portfolio Value Analysis approach involves using the most granular information generated by the segments to help companies understand the sum of the parts value of their business bottoms up. Key drivers of value for each of the segments should be identified and finally identify which segments could be potential candidates for a spin-off. This would be the segments that would be able to unlock more value if operated as stand-alone entities.

·      A pre-spin value capture roadmap should be established.

Enhancing value capture in order to identify ways to improve performance and establish a well-defined value creation roadmap is the next step. Revenue growth, capital efficiency and margin improvement are typically the key levers of value. Ways to find the balance between optimization and growth and create an operational improvement plan six to eight months before spinning-off the business should be sought. A clear roadmap including a cohesive strategy of how the spin-off will create value and what metrics need to be focused on is the best guarantee that it will be accretive to shareholders.