Bucking the merger trend of the 1990s, corporations are splitting up and spinning off business units with the traditional belief that restructuring will create value.
After all, academic research suggests that company splits and spin-offs are positive investor events. Investors applaud restructuring announcements by companies that have limited growth opportunities or complex units that hinder a comparison of like businesses, notes Robert Bruner, dean of the University of Virginia’s Darden Graduate School of Business Administration at the. In fact, the average share price increases by 3 percent after an announcement of a split, according to research by James Rosenfeld, associate professor of finance at Emory University’s Goizueta Business School.
Contrary to what research predicts will happen in the markets, however, recent news of Cendant’s restructuring spawned declining share prices. The company’s share price has yet to recover from its October 24 announcement that it would split up into four separately traded businesses—travel, hotel, real estate, and car rental.
To be sure, there was something different about Cendant’s announcement from that of the run-of-the-mill restructuring. Around the same time it revealed that news, the company disclosed its expectations of lower earnings for the fourth quarter. The negative earnings news outweighed the good news of the split, observed Ivan Feinseth, director of research at institutional brokerage firm Matrix USA.
Indeed, Cendant’s experience could prove to be an investor-relations lesson for companies that must report both good and bad news simultaneously. “There was a great deal of chatter among investors [as to] whether Cendant was trying to obscure its negative earnings outlook with this announcement,” said Bruner. “That is the type of cynicism companies need to avoid,” he said, declining to speculate on whether the announcement was an attempt to cloud over the bad earnings news. A Cendant spokesperson commented however, that “the timing of the announcement was not in any way intended to obscure the earnings.”
Once a Wall Street darling, Cendant was tainted by a $3 billion accounting fraud in 1998. Irwin Kishner, chair of the corporate department at the Herrick, Feinstein law firm, said that he would understand a certain level of investor cynicism. Yet he believes the corporate split-up is the right move at the right time given the company’s history and the drag on earnings created by its existing structure.
The split’s creation of separate businesses should curb the shareholder confusion that has resulted from trying to evaluate a large, diversified entity, observers say. “By separating, you could have some clarity and it should unlock the value,” said Feinseth.
Maybe it will, but it hasn’t so far.
A Negative in the Net
Market history reveals other examples of closely-timed good and bad corporate news that resulted in a net negative for the company. On January 22, 2002, for instance, Dennis Kozlowski, who was then Tyco’s chief executive, announced a restructuring of the conglomerate after reporting the week before that it wouldn’t meet earnings forecasts. At about the same time, Tyco was reporting earnings restatements and investigations by the Securities and Exchange Commission. “The announcement of the split-up merely accelerated the decline in the share price,” said Bruner, who details the events in his recent book, Deals from Hell.
The close timing of positive and negative news at Mattel in 1998 resulted in a stock drop and a failed acquisition. Around the time of Mattel’s announcement in December 1998 that it would acquire the Learning Company, the company also reported sharply declining earnings per share.
Investors at the time were concerned that Mattel was attempting to paper over the weakness in its core earnings through the use of mergers and acquisitions, according to Bruner. In the end, the acquisition failed, and Mattel’s CEO and CFO were sacked.
As for Cendant, time will tell whether its restructuring was a move purely aimed at unlocking value, according to Bruner. Many investors sold the stock because the timing of the restructuring and earnings announcements created “an unfortunate impression,” he observed. Over the next six to 10 quarters, the separate businesses will present a more transparent picture of their operational health—evidence that will show whether the sum of the parts was worth more than the whole, according to the business-school dean.
Experts have advice for companies with mixed news to deliver. “Rule number one should be: Don’t endanger shareholders’ trust and confidence,” warns Bruner. Report bad news straightforwardly and separately, and present the merits of a restructuring on its own terms, he said.
Others agree that dealing out different messages separately could benefit the company. “Headlines will focus on the negative, regardless of how balanced the press release is,” said Kenneth Menges, a senior corporate law partner at Akin Gump. On the other hand, there may be enough flexibility within the rules of timely notification to issue separate press releases, he says. Menges suggests disclosing negative news first and then releasing the positive news separately.
“It is critical that companies be completely factual in their description of good news and minimize puffery,” adds Menges. “It is not just investors who are skeptical—the Securities and Exchange Commission and the exchanges are watching these releases to see if there is an attempt to manipulate the market by putting positive news in an inappropriate way.”
Kishner agrees that companies would be ill advised to manage information it must publicize. He also encourages companies to err on the side of caution, particularly in the currently stringent regulatory environment. The guiding principle for corporate announcements should be whether it would affect the investment decision of a reasonable investor, he said. “The safest advice is: disclose, disclose, disclose.”