Is it time to split up?
Each week brings with it news of the latest multi-business public company looking to ignite shareholder returns by separating. Sometimes compelled by external pressure from activist investment funds, spin-offs are taking place across a range of industries. HP Inc. and Hewlett-Packard Enterprise, eBay and PayPal are among the most recent examples, and the list keeps growing.
Corporate breakups may be in vogue, but are they worth it? Separations are costly; one-time costs typically amount to 1% to 2% of revenue, and sometimes more for the most complex separations. They’re time-consuming, too, generally taking 12 to 18 months from decision to close. As anyone who has embarked on a separation can attest, they’re also resource intensive and distracting for an organization, causing a high degree of inward focus.
The big question for boards and CEOs pondering such a move is, “Does the breakup succeed in creating shareholder value?” The answer is, “sometimes.” We determined this by analyzing the performance 18 months post-separation of 40 transactions involving companies valued at more than $1 billion in the 2001 to 2010 time frame. We focused on deals in which two separate public companies were formed out of a portfolio in which there had been some level of strategic and operational integration.
Based on our analysis, the top third of separations delivered significant value: The combined market cap of the new businesses after separation exceeded their pre-spin value by more than 50%. That’s the good news. But in another one-third of the cases, the combined market cap of the new companies was 40% less than their pre-spin value 18 months after separating.
This tells us that separations are “high beta” events, requiring CEOs and boards to thoroughly understand the most important contributors to success and to take a measured approach to spin-offs, even in the face of external pressures from investors.
A number of factors distinguish winners from underperformers. First, a seemingly obvious point, but one that sometimes doesn’t garner sufficient attention and rigor: The breakup must enable one or both of the companies to do something they can’t do today, like gain access to new markets, significantly reduce costs, build new capabilities or make strategic investments. For a separation to have merit, a company’s existing operating and ownership structure must preclude those actions. In the best of cases, executives can articulate the clear and compelling rationale for separating and quantify the value that would be created from each of those actions.
In addition to executing the transactional elements of a breakup, winners produce plans and actions for change that ensure both companies will be competitive in their future markets. The risk from too little change is that the new companies find themselves as just smaller versions of the original entity, with stranded costs and no new advantages. The risks from too much change are that the separation process falters because it is overwhelmed by complexity, or the new companies stumble in their first few quarters of stand-alone performance, having failed to digest all of the changes.
Separations always result in extra costs from the need to duplicate activities and personnel, or from losing economies of scale. The best companies develop a specific plan for offsetting these incremental costs, typically over a period of 12 to 24 months after the separation, and they set these expectations with investors before the separation is completed.
During a separation, competitors frequently attempt to disrupt customer relationships, and employees often become distracted. That’s why, as part of the decision to split, the most successful companies evaluate whether the separation will create an opening for a competitor to attack; which critical initiatives they’ll need to insulate from the distraction of the separation process; and whether they’ll be able to retain key talent. They take appropriate actions during the separation process to mitigate those risks.
Finally, executives of successful separations anticipate the talent depth required for both new companies, during and after the split. After separating, both companies need organizations with the capabilities and the credibility necessary to operate as public companies and to compete effectively on a stand-alone basis. In the best of cases, executives decide as early as possible which future critical roles they can fill internally and which would require new talent. Tackling these decisions early allows sufficient time for external searches. It also improves the odds that external hires can be on board before the split and can take part in designing the new companies.
Andy Pasternak is a partner with Bain & Company’s Chicago office, and Jim Wininger is a partner with Bain’s Atlanta office.