Vecta on Spinouts

Vecta Consulting

Vecta on Spinouts

Spinouts are often seen as a way to recoup an investment in an area that no longer fits the parent company's core strategy. With the carrot of a potential IPO or trade sale as the exit route for the parent without the trauma of closing down a major division combined with greater freedom of the spinout's management to plot their own course, spinouts appear to be "win-win" for the parent and the spinout; yet spinouts are rarely successful.

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There are good reasons to spin out subsidiaries whose capital and management needs are significantly different from those of the parent. However care is needed to ensure that the spinout is given sufficient control of its own destiny, is operationally independent, is not merely a financial engineering tool, and is not the true future of the business; otherwise the spinout event will be expensive and could be suicidal.

There are some great successes. Vodafone was born out of Racal, the communications group; Zeneca, now part of AstraZeneca, was part of ICI, the general chemicals group. In these cases, like many others, shareholder interests were best served by fully demerging the misfit. Existing shareholders were given shares in both the "old" and "new" businesses and the new companies were truly indepedent of the old. It will be interesting to compare the futures of mmO2, recently fully demerged from BT, with TIM which remains closely connected with Telecom Italia.

Here are four examples of expensive spinouts that failed one or more of the four tests:

Thermo Electron, in the 1990s pursued a strategy in which it spun out a several dozen divisions selling some of their stock in a series of partial IPOs so as to not only raise funds but also to free up management and hence attract and retain higher calibre staff than might be possible within a larger corporation. In the mid-1990s the strategy was hailed as a success with TE's market valaution trebling in value over a few years. Only a few years later, after a loss in one of the spun out divisons led to a "knock-on" decline in the parent's stock price, the strategy was reversed and the spun out divisions either re-absorbed or divested completely. The spinouts were seen not to have had enough control over their own destiny yet had to support administrative functions that could have been shared with others within a conglomerate.

c-quential, Inc. was spun out of the international management and technology consultancy Arthur D. Little in 2000. It was based on their highly successful global TMT consultnacy yet by early 2001 was being re-absorbed into their Global Management Consultancy operations. While market conditions in October 2000 were the major factor in preventing the planned partial IPO, they shared a number of adminstrative services with the parent that would have limited their freedom to act independently. The millions of dollars spent on the spinout and preparing for the IPO were a significant factor in the eventual breakup of Arthur D. Little.

Enron's use of off-balance-sheet partnerships created more problems than it initially solved. Their focus, like many other companies, on quarterly earnings tempted management to hide the debts incurred from investments essential to the ongoing growth of the business and so make it look healthier than it was. These measures cannot succeed over the long term but are often enough to secure substantial personal financial rewards to those closely involved at the expense of the misled shareholder.

Many of the world's telecommunications players have spun out their mobile subsidiaries only to find them achieve valuations much higher than their former parents. When stock markets let the stocks ride high and mobile businesses needed massive capital to build out their networks, even crown jewels had to be sold off. Fairness to shareholders depended on the basis of the share split.

Financial re-engineering of a corporation may yield short-term financial benefits to senior management and advisers but rarely delivers long-term value for shareholders. University spinouts, whether real or imagined, are more likely to succeed.

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More info from:

Frank.Morris@vecta5.com

Vecta Consulting Limited, Mulberry House, 2 The Spinney, Broad Lane,
Cottenham, CAMBRIDGE, CB4 8RN
Tel: +44 (0) 1954 250222, Fax: +44 (0) 1954 252333

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