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Companies Enter the Spin Cycle


By the Financial Times (Financial Times) -- Ed Breen, Tyco International chairman and chief executive, was setting out the group's plans to split. The three new entities would "be able to move faster and more aggressively … by pursuing their own growth strategies as independent companies," he said.

That was back in January 2006. This week, he was offering a similar explanation for the industrial group's plans to do a further three-way separation.

He joins the procession of U.S. executives explaining why they intend to divide their corporate empires.

Since mid-July, these companies have included media conglomerate McGraw-Hill; Kraft Foods; and oil group ConocoPhillips which said it would demerge its refining and marketing operation.

One reason why demergers are popular is that they often result in a strong share price performance.

A wealth of academic research supports this assertion, even though studies may disagree as to the cause -- variously citing factors such as more powerful incentives and greater freedom for management teams; higher valuations because equity markets prefer pure play companies; and the premium that comes from the prospect that spin-offs can more readily be taken over.

The U.S. tax regime has long meant that a properly-structured spin-off can be a tax-free way to streamline a group. But additional factors lie behind the fashion for splits.

Some people see the financial crisis of 2008-09 as a prompt. Bill Huyett, a partner at consulting firm McKinsey, says it "triggered a more fundamental look by corporate boards at what businesses they owned and why they owned them".

Joe Cornell, who runs Spin-Off Advisors, believes the crisis had an effect. "When the market collapsed, there were a lot of spin-offs that had not yet been announced that were shelved then and are coming through now".

Another reason sometimes cited is the difficulty of running a widely diversified group at a time when creating value in conglomerates must go beyond generic tools such as budgeting and cost-cutting.

"Now you need more sector-specific ways to create value, and it's difficult for a single management team, no matter how able it is, to stay current and go deep on the talent and technology that affect businesses in every sector of the economy," Huyett says.

Some companies have been encouraged to look at spin-offs because turbulent markets for initial public offerings and limited lists of prospective buyers make those options less attractive.

Yet advisers believe there are more positive reasons to adopt this approach to slimming a business, pointing out that the high level of cash on corporate balance sheets means companies are less likely to need the money that would be raised by a sale or partial IPO.

"The spins we have seen this year are not generally being done for defensive reasons," says Carsten Stendevad, head of the financial strategy group at Citigroup's investment bank. "It is a proactive strategic choice."

At the same time, depressed stock prices encourage companies to seek ways to persuade equity markets that they merit a fresh appraisal.

"When a board is grappling with a macroeconomic environment where growth is tepid, there are not a lot of possible catalysts for a company's valuation," Stendevad says. "Now is a time when revealing a business line's high-growth prospects is likely to be rewarded.

The U.S. spin-off momentum comes partly from the success of activist investors, who are seen to have played a role in, for example, Fortune Brands' decision to split.

This is one reason why the vogue for spin-offs is not reflected at European companies. "Compared with their U.S. counterparts, activist shareholders in Europe have generally had a tougher time," says Daniel Stillit, special situations analyst at UBS.

He also points out that the record of spin-offs in Europe has not been encouraging of late. "The most recent large-scale demerger, of PostNL and TNT Express in May, was the result of shareholder activism," he says "That hasn't, so far, been a resounding success for shareholders."

Of course outperformance is not guaranteed. In the UK, three profit warnings and the abrupt exit of chief executive Jim Marsh from Cable & Wireless Worldwide -- which demerged from Cable & Wireless plc in March 2010 -- scarcely act as an advertisement for separation.

Still, the relatively low number of high-profile casualties from spin-offs gives the approach wide appeal. Some advisers believe that General Electric, the standard-bearer for conglomerates, could come under pressure to split off its financial unit. Others see Johnson Controls, which combines automotive interiors with a heating and air-conditioning division, as another candidate for separation.

In the UK, analysts say BP could consider a split of its operations as a way to increase value.

Tyco may be the latest to announce a spin-off so far this year: it is unlikely to be the last.

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