In today’s fast-moving landscape, corporate spin-offs have become a popular strategy for companies looking to unlock value, streamline operations, and enhance shareholder returns.
It’s a strategic process in which a parent company separates a portion of its business to create a new, independent entity. This process can take several forms, including:
- Distribution of shares to existing shareholders
- Direct sale of shares to new investors
- A combination of both methods
But how do corporate spin-offs actually create value for the parent company?
To answer this question, we’ve outlined some of the ways spin-offs can lead to increased value for both the parent and the newly formed entity, with real-world examples showcasing each benefit.
But before we get into that part, let’s kick things off with some context.
What is a Corporate Spin-off?
A corporate spin-off is created when a parent company separates a portion of its business to create a new, independent entity. The newly-formed company operates autonomously, complete with its own management team, resources, and strategic objectives.
In most cases, shares are distributed on a pro-rata basis, ensuring that existing shareholders retain ownership of all assets and liabilities they had before the spin-off took place.
There are various reasons why a corporation would choose to create a spin-off, including tax benefits, regulatory requirements and the need to focus on core activities. Another potential reason to create a spin-off is the need to divest in units that are underperforming. Turning them into an autonomous spin-off, with its own team and investors, increases the chances that the new entity will succeed.
Spin-off vs split-off: what's the difference?
Both spin-offs and split-offs are corporate restructuring strategies that involve separating a business unit from the parent company. However, they differ in terms of how shares and ownership.
We’ve listed some of the main differences in the table below:
Now that we’ve covered some of the spin-off basics, let’s take a look at some of the ways they can unlock value.
1. Spin-offs enable companies to focus on the core business.
One of the primary ways corporate spin-offs create value is by enabling the parent company to concentrate on its core activities.
Spinning off a non-core or underperforming business unit enables the parent company to concentrate on its traditional core competencies, leading to enhanced operational efficiency and profitability. The same goes for the newly formed entity, which will have more autonomy and space to further develop its own capabilities, regardless of whether or not they align with the parent company’s broader corporate goals.
Example: Altria Group and Philip Morris International (PMI)
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Back in 2008, Altria Group spun off its international tobacco business, Philip Morris International, allowing both entities to focus on their respective markets (i.e. home in the US and abroad). The move was prompted by the increased regulation and declined cigarette sales in the US, which led the parent company (Altria Group) to believe it could be more profitable to turn its overseas operation into a separate entity.
Since the spin-off, both Altria and PMI have experienced growth in their respective markets, with PMI, in particular, expanding its presence in emerging markets.
2. Spin-offs have the potential to unlock hidden value.
Spin-offs can unlock the hidden value of a business unit that may have been missed or overlooked within the larger parent company.
Spining-off a seemingly underperforming unit gives it the opportunity to attract new investors, access new resources, and pursue its growth goals more effectively and with more focus. In many cases, the new autonomy can lead to better financial performance, increased market valuation, and higher shareholder returns.
Example: ConocoPhillips and Phillips 66
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Back in 2012, ConocoPhillips spun off its refining, marketing, and transportation operations into a separate, publicly traded entity called Phillips 66. Prior to the spin-off, the unit that would eventually become Phillips 66 struggled to compete for resources and attention within ConocoPhillips, which was primarily focused on exploration and production. Becoming a separate entity enabled it to operate independently, attract new investors, access new resources, and implement more focused strategies tailored to its specific industry segment.
Shortly after the spin-off, both companies increased their market cap size, with Phillips 66 reporting triple-digit gains not long after its first day of trading.
3. Spin-offs can enhance operational efficiency for both entities
By separating the parent company's operations from those of the spin-off, both entities can achieve greater operational efficiency.
The newly spun-off company can implement tailored strategies, management structures, and cost controls that are more suitable for its specific business environment. This enhanced efficiency can lead to increased profitability and shareholder value.
Example: Hewlett-Packard and HP Enterprise
In 2015, Hewlett-Packard (HP) split its operations into two separate, publicly traded companies:
- HP Inc., which focused on personal computers and printers
- Hewlett Packard Enterprise (HPE), focused on enterprise solutions (e.g. servers, storage, etc.).
The spin-off enabled each company to focus on its own core competencies and implement tailored strategies, structures, and cost controls specific to each individual niche. For example, after becoming a separate entity, HP Inc. simplified its supply chain and consolidated its product lines, which led to improved profitability and shareholder value.
The spin-off also enabled HPE to adopt a more agile management structure, optimising its resource allocation and enhancing its operational efficiency.
4. Spin-offs can create value by reducing complexity
Complexity can be a significant drag on a company's performance, particularly when we’re talking about large, diversified organisations. By spinning off non-core businesses, a company can reduce complexity and enhance transparency, making it easier for investors to understand and value the remaining operations.
Example: Viacom and CBS Corporation
In 2006, Viacom completed the spin-off of its broadcast television and radio division, which became CBS Corporation. The spin-off helped reduce the complexity of Viacom's vast portfolio of media assets and enabled both entities to focus on their respective business segments.
As an independent company, CBS Corporation was better able to concentrate on its businesses (e.g. Simon & Schuster publishers, the Showtime cable network and Paramount Parks), implementing strategies specific to these segments and responding more effectively to the rapidly changing landscape.
Meanwhile, Viacom was able to refocus on its cable television networks and film production businesses, streamlining its operations and optimising its resources.
5. Spin-offs can create value through better governance and accountability
A well-executed spin-off can also lead to better corporate governance and increased management accountability. With separate boards and management teams, the parent company and the spun-off entity can establish more focused performance metrics and incentive structures, aligning management's interests more closely with those of shareholders.
Example: Abbott Laboratories and AbbVie
In 2013, Abbott Laboratories spun off its research-based pharmaceutical business, AbbVie, allowing both companies to establish distinct governance structures and performance metrics. The separation has enabled each company to pursue its strategic objectives more effectively, delivering strong returns for shareholders. As explained by former Abbott Chief Financial Officer, Tom Freyman:
“It was one of the most successful [spinoffs] in the market. Separate, we were valued more than together. The combined stock has increased 78% since the separation was announced in October 2011.”
Final thoughts
As illustrated in the examples above, corporate spin-offs create value in a variety of ways; however, in most cases, their success will be dependent on a number of factors:
- Strategic goals: Having a clear rationale to create a spin-off, e.g. improved focus, reduced complexity, or enhanced capital allocation, is critical to its success.
- Efficient execution: Proper planning, communication, and execution of the process are essential to ensure a smooth transition and minimise disruption to the entities involved.
- Sturdy governance set-up: The new entity needs a capable management team and an effective governance structure in place to drive growth and succeed in the long run.
- Financial stability: Both the parent company and the spun-off entity should have a solid financial foundation, ensuring they can operate independently and pursue their strategic objectives.
Be sure to carefully consider these factors if you’re thinking of setting up your own corporate spin-off.
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