Breaking big companies

Conglomerates start spinning off units because they believe they are able to unlock value

Companies all of a sudden seem to have a burning desire to break up. That appears to be the verdict sweeping some of the biggest corporations on the planet last week.

After once-mighty United States conglomerate General Electric announced on Tuesday that it’s breaking itself up into three separate units, Japanese industrial giant Toshiba and US drugs and healthcare behemoth Johnson & Johnson followed suit on Friday, with spin-off announcement of their own.

Having struggled under its sheer weight for decades, GE finally decided to break itself up into three separate publically traded companies focused on healthcare, power and aviation. The health unit will be spun off in early 2023. GE will combine its renewable energy, power equipment and digital businesses into a separate unit that will then be spun off in early 2024. The remaining company will consist of GE aviation, the company’s engine-manufacturing operation.

Toshiba said on Friday that it is also breaking itself up by spinning off its energy infrastructure and computer devices units into two separate companies. The rest of its assets will be held under the Toshiba name.

Also on Friday, Johnson & Johnson said it is splitting into two separate companies. One as-yet-to-be-named unit will focus on healthcare products like Band-Aids, Listerine and over-the-counter medicines. The other – which will keep the J&J name – will encompass prescritption durgs and medical devices.

Each company has its own unique reasons for wanting to shrink, but in general, conglomerates start spinning off units because by doing so, they believe they are able to unlock value. In general, spin-offs enable each company to obtain capital consistently based on its own operations and each company can raise capital according to the way capital markets affect each company’s business. The spin-off will provide investors with a clearer view of each company’s business operation which may attract new investors.

Spin-offs can alleviate management problems of both parent companies and spun-off companies, because both kinds of companies often have different lines of business and different business environments. Moreover, parent companies usually focus their attention and resources on their core operations. Consequently, the spin-off allows the spun-off company to negotiate management, finance, and resource issues with its own board of directors and to make decisions for itself.

In addition, many portfolio managers prefer “pure play” companies. Investment professionals may be interested in one or the other of a company’s basic businesses, but not both. To the extend that financial markets are incomplete, spin-offs provide investors with a wider range of investment opportunities appealing to different investor clienteles. In addition, the issuance of separate financial reports on the operations of the subsidiary faciliate the evaluation of the firm’s performance. Thus, this technique may enable mangers to uncover the hidden value of a subsidary.

Since parent companies and some subsidiaries often have unrelated business lines, they also have different business risks, which affect operating earnings. Parent companies sometimes spin-off sunsidiaries to protect both companies from each other’s risks, which generally stabilizes the earnings of the parent company.

Another important motive for corporate spin-offs is to take advantage of tax benefits. Tax advantages can be achieved by the creation and spin-off into real estate investment trusts (REITs). As long as these entities pay out 90 percent of their earnings to shareholders, they are tax exempt, permitting the subsidary company to shield income from taxes.

Finally, laws and regulations may cause companies to spin-off subsidiaries voluntarily or involuntarily. Antitrust laws in the US promote competition by breaking up firms that have become monopolies such as the Big Tech companies. Nevertheless, parent companies sometimes spin off their subsidiaries to split up regulated and unregulated companies or to avoid legal hurdles associated with ownership of certain kinds of companies. A spin-off in such scnearios allows the unregulated companies to operate and expand unfettered by regulation.

Despite the possible advantages of being a subsidary such as lower costs of borrowings, savings on administrative costs, expert management, and reduced costs through centralised purchasing, the subsidiary status also has possible disadvantages such as lack of knowledge of subsidary needs, loss of freedom to operate as the subsidiary sees fit, and unnecessary and inhibiting policies. When the value of these disadvantages exceeds the value of the advantages, a subsidiary is better off operating as a separate company. Hence, both parent and subsidary companies are free to realize their full potential value after a spin-off.

Each company has its own unique reasons for wanting to shrink, but in general, conglomerates start spinning off units because by doing so, they believe they are able to unlock value. This means that they think investors see less value in the company’s businesses if they remain combined, and that shareholders will be better off it those businesses are spun off into separate companies.


Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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