Company Spin-offs

Divide and Conquer?

Hauptversammlung der Daimler AG
Will a three-way split help or hinder Mercedes-maker Daimler? Source: dpa

The logic seems pretty clear. If you owned a big house, chances are that it would be worth more after being converted into several apartments than it would be as a single home. But is the same true of large businesses with several separate divisions?

That’s a question many German firms are grappling with at the moment. The country’s business sector is riding a wave of spin-offs, driven by investors keen to create value and hoping that the sum of the individual parts is worth more than the whole. It’s a risky strategy.

The latest company to throw the dice is carmaker Daimler, which is to split into three independent companies for passenger cars, goods vehicles and financial services. The Mercedes parent will retain control of all three, with chief financial officer Bodo Uebber saying the aim is “to be able to respond as quickly and flexibly as possible to new market developments.” To ensure that staff are on board, the group has promised that there will be no compulsory redundancies before the end of 2029 and that it will invest €35 billion ($40.8 billion) in its German sites over the next seven years. It estimates that the first stages of its restructuring will cost €100 million.

Other recent examples of the break-up trend include Germany’s top two energy groups RWE and E.ON, which have hived off and set free large parts of their business under the names Innogy and Uniper, respectively. And chemicals and pharmaceuticals giant Bayer spun off its plastics activities under the name Covestro, and floated the new company on the stock market.

These radical restructuring programs are often due to pressure from shareholders, who demand a stronger focus on the core business and value creation. “The complexity of large companies with several divisions often leads to costs and inefficiency. Smaller units, on the other hand, promise greater clout and flexibility,” said Berthold Fürst, head of mergers and acquisitions at Deutsche Bank in Germany. He added that many options for increasing the value of companies were already exhausted following an eight-year boom on the stock markets.

Some managers are making such drastic cuts that it is unclear what will actually be left of their company.

Jens Kengelbach of Boston Consulting Group, who advises companies on restructuring measures, thinks there are also other motives. He said companies wanted to have a broad-based structure during crisis periods, as this allows them to offset weaknesses. In boom periods, however, investors want clear business models. “If the units are separate, shareholders can make better use of opportunities and compare themselves against other companies,” he explained. He added that new technologies are also driving the trend, as spin-offs allow companies to adapt their business models and raise capital.

There have been similar spin-off waves in previous boom times. Not all participants benfitted. Pratiker, a chain of DIY stores that was spun off from German retail giant Metro in 2005, struggled before eventually going bust in 2013. And Qimonda, a semiconductor manufacturer split off from Infineon, lasted only two years before filing for insolvency in 2009.

Will the new wave meet with more success? Some managers are making such drastic cuts that it is unclear what will actually be left of their company. This includes engineering titan Siemens. It plans to float its “Healthineers” medical technology division on the stock market next year, and has already hived off several other areas of its business: Its electric-car drive business was placed in a joint venture with automotive supplier Valeo; its wind power activities was merged with the Spanish manufacturer Gamesa; and it is in the process of merging its train business with French rival Alstom.

Chief executive Joe Kaeser hopes that the individual units will become stronger through cooperation agreements and that they will become more independent and flexible. But the restructuring measures have gone so far that many people are asking whether Siemens will end up being anything more than a holding company.

Others are also asking a lot of their offshoots. Metro began the process of splitting its business into two independent companies for food and consumer electronics in March 2016. They are now listed on Germany’s MDAX (mid-caps) index. Metro said its medium-term goal is for “the two shares combined to be worth more than previously.” But the companies are a long way from this target, with the combined price currently down around 5 percent compared to their value before the split. The organizational changes made very little difference to the operational problems experienced by the group’s retail stores.

However, it seems that overall, share prices do perform better following a spin-off. A US index listing only spun-off firms has outperformed the average for all companies by more than 4 percentage points, for example. And when German fertilizer group K+S unveiled its new strategy a few weeks ago and did not announce plans to dispose of its salt business as anticipated, its share price promptly plummeted.

But there are no guarantees. Hans-Ulrich Wilsing, a lawyer at Linklaters who advises large companies on transactions, warned that managers often underestimate how expensive it is to dissolve a group that evolved over the years, and the amount of upheaval it causes. Costs are similar to a takeover, he said, and it is rare for this kind of transaction to take less than a year. There is also a lot of explaining to be done to customers, tax authorities, shareholders and, above all, employees.

So it seems that if you are going to convert your house, it’s best to get it in order first.

A longer version of this article originally appeared in the business magazine WirtschaftsWoche. To contact the authors: online@wiwo.de

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