Spin-offs are a popular tool touted by activist investors to unlock value for shareholders. The pandemic hasn’t slowed the popularity of spin-offs down. When looking at Bloomberg data, the number of announced spin-offs year to date in 2021 are already higher vs. the last ten-year average (Figure 1).
A recent example of activist shareholders advocating for a spin-off is the call by Third Point for Royal Dutch Shell to be split up. In a letter to its investors, Third Point writes that Royal Dutch Shell’s share price had delivered an annualised return of 3% over the past two decades with decreasing returns on invested capital. They argue that shareholder value would be unlocked if the company was split into a standalone legacy “dirty” energy business and an LNG / Renewables “clean” business. Often on an Excel spreadsheet, a sum-of-the-parts calculation makes a separation look like a no brainer. However, one must also think of the practicalities around splitting up a company. Value creation may not necessarily be guaranteed.
A spin-off gives the parent / spinco the opportunity to take advantage of prevailing peer multiples which may be attractive at that time. Altron is a recent local example of taking advantage of attractive peer multiples. At the stage of unbundling its UK business (Bytes), Altron had traded at an average of 10x forward Price Earnings (PE) multiple over the preceding five years. On the other hand, Bytes’ listed peer, Softcat, was trading on a forward PE multiple of 35x. The Bytes unbundling and separate listing resulted in Bytes eventually attracting a 35x PE multiple and creating more than 100% of total returns in less than one year.
A spin-off is also a chance to eliminate a holding company discount that a division may be attracting. Furthermore, investors get direct access to a particular asset and can make the decision if they don’t want to be invested in a certain type of business. Anglo American recently spun out its thermal coal business which has given investors the option of whether they want exposure to what is usually viewed as a “dirty” business from an ESG perspective. International Paper spun out its publishing paper business so that investors can choose if they want exposure to the graphic paper business, which is an industry in structural decline.
There can also be operational benefits of spin-offs. Once spun off, the parent and spinco are nimbler and can have a focused strategy. As an example, Continental took the strategic decision to spin-off its powertrain business and list it as Vitesco. One of the key rationales for the spin-off was that Vitesco will now have the autonomy to enable it to focus entirely on the shift towards electric mobility.
The one drawback of a spin-off is that it may result in the creation of one or more subscale businesses that institutional investors may not be able to invest in due to the exclusion of the spinco from key indices. If spun out by way of unbundling to shareholders, this could result in investors receiving shares that institutional investors may not be able to hold, and this may lead to selling pressure on the parent / spinco’s shares. Imperial unbundled its automotive business, Motus, to shareholders in order to create value in late 2018. However, the market capitalisation pre-unbundling of R34bn is still higher than the current R32bn (even post a take-out of Imperial by DP World). This can be attributed to the unbundling creating two smaller companies that fell out of key indices, and thus certain institutional investors were unable to remain invested.
In conclusion, a spin-off has the potential to create significant value for shareholders, however, investors should keep in mind that not all spin-offs are created equal. Consideration must be given to a wide variety of factors beyond the sum-of-the-parts calculation on an Excel spreadsheet.