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 / Third Quarter 2002 / Issue 28(originally published by Booz & Company)


Breaking Up Is Hard to Do — and to Manage

Three rules for ensuring that spin-offs create — and don’t destroy — value.

Illustration by Lars Leetaru
Even a casual observer of the business press would have noticed over the past several months that amicable divorces have become quite the rage within large companies. Financial-services giant Citigroup Inc. is well down the path toward spinning off 20 percent of the $9 billion Travelers Property Casualty Corporation unit to shareholders by the end of this year, four years after it acquired the insurance company. Paper peddler Georgia-Pacific Corporation is also holding out a cup to investors — in this case, its $12 billion Dixie Cup unit, which it plans to spin off. Tyco International is an almost daily spin story: Earlier this year, the embattled multifaceted conglomerate announced, then withdrew, ambitious plans to divide itself into four public companies; and in April, it launched plans to spin off or sell its finance unit, CIT Group Inc., which it had acquired in 2001.

Outside the land of the giants, scores of other publicly traded companies are breaking off pieces and offering them to shareholders. Allergan Inc. is spinning off its optical medical device business, to be called Advanced Medical Optics Inc. The Goodrich Corporation is doing likewise with EnPro Industries Inc.

Others have recently taken chunks public, as the Rockwell International Corporation (since renamed Rockwell Automation Inc.) did when it completed the spin-off of its communications and avionics unit, Rockwell Collins Inc., in mid-June 2001. So common are the carve-outs and bust-ups, in fact, that specialized firms have arisen to counsel investors on the ins and outs of the spin game.

Sobering Reality
The allure of the spin-off is quite simple. Splitting a major company into two or more “pure plays” promises to unlock value for shareholders. The problem is that value can be elusive. Indeed, more often than not, it’s illusory.

A Booz Allen Hamilton study of all 232 spin-offs by S&P 500 corporations during the 1990s found that “spins” are a lottery. Like a casual gambler in Las Vegas, the unwary investor is likely to lose. And if investors lose in a constrained economic environment, so may the other stakeholders — employees, managers, and the parent company, which frequently holds on to a significant cache of the spin-off’s shares.

We are not criticizing spin-offs generally; the strategy, in and of itself, is neutral. To be sure, in some cases, a spin can unlock tremendous value. Within a year of the spin-off of the Cabot Microelectronics Corporation, the combined market value of the infant and its parent, chemical company the Cabot Corporation, was double that of Cabot alone, equaling $4 billion. Although both companies’ shares fell afterward, in late May 2002 the companies were still worth $2.85 billion, a 45 percent premium over the unspun enterprise.

But for every successful spin, there are two that fail to live up to their potential. It’s vital that boards of directors, executives, and especially senior managers of the spin-offs themselves understand the special pressures under which spin-offs labor, so that they can develop and execute growth strategies that will fulfill the promise.

If you were an investor during the 1990s, you could have done well buying into spins — but only if your pockets were deep. A shareholder who invested in every one of the last decade’s 232 spins before the divestiture and held the shares for two years would have beaten the returns of the S&P 500 by 3.8 percentage points. But that figure masks a more sobering reality: While one-third of the spins generated attractive returns, two-thirds underperformed the stock market. In its first two years, the median-performing spin-off generated annual returns for shareholders that were 7.7 percentage points worse than the S&P 500. Even the mildly attractive average returns for diversified investors have a catch: They were the result of the few instances in which the extraordinary post-spin-off earnings growth of either parent or subsidiary created enormous value for shareholders.

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