Spin-offs are on the rise

Phil Dunmore, MD of progamme management consultancy PIPC argues that in their haste to obtain the decree absolute, demerging businesses are threatening their long term viability

Phil Dunmore PIPC

European CEO, May 2010

Demergers are in fashion again. After years of rampant M&A activity, reality has come home to roost with the global economy and to a certain extent the EU’s competition committee forcing the break-up of European businesses. According to research from The London School of Economics, a lack of private equity investment has also been instrumental in the recent flurry of demerger activity. Liberty International, Petrofac, Cable and Wireless and Carphone Warehouse are all involved in spin-offs while Fiat and ING are among those rumoured to be also preparing for business divorce.

The trouble is that divorce is rarely pretty. Robin Williams’ lurid, stand-up comedy assessment of the marriage split springs to mind - “Ah yes, divorce, from the Latin word meaning to rip out a man’s genitals through his wallet” – a painfully accurate analogy when applied to demergers too. More often than not there is hurt, a dominant party wanting to sell off an unwanted or underperforming division and a huge urge to get aggressive, strip out the best bits and set it adrift to fend for itself in the real world. Those left abandoned inevitably want to fight for the spin-off business, their shareholding and their futures. It can be messy.

Results of demergers are mixed too. AstraZeneca’s share price soared following the split from parent ICI, while the demerger of Mondi from Anglo American has been less successful. It’s an unpredictable business in the sense that every demerger is different. There is no ready-made map or standard one-size-fits-all process.

The problem that the majority of CEOs also face is that this tends to be new territory. Splitting up businesses is not an everyday activity for chief execs. They may have been through a few M&As and witnessed first-hand the complicated integration of departments, technologies and personnel but demerging is very different. So what can CEOs do to ensure that any plans to demerge are not left to run wild and end up costing billions in lost revenue and stock value?

When, for whatever reason, businesses decide to split, to sell-off a division or demerge, it is rare for there to be openness and amicability due largely to a wide range of vested interests. There are also compliance and regulatory issues to consider which vary both by industry and country, even within the EU. Impact on customers and clients also has to be taken into consideration as well as the actual management, structure and transition of business assets. It’s also extremely important to understand the implications for the balance sheet and the need to manage external communications to shareholders and the public. In short, it’s a minefield.

Perhaps one of the most misunderstood elements of demerging is the fact that there has to be an interim state, a sort of purgatory if it drags on too long but in essence a necessary evil. This interim state can last anything from two months to more than two years. It is where the divested company is still tethered to the mothership as such but starts to operate as an independent business. Setting the new entity total adrift only happens when all the various bits of unravelling have been completed and tested and the new business is on secure footing to make its own way in the world.

Of course the speed at which this happens can have huge affects on morale and motivation of staff. If it takes too long, key personnel, whose natural urges to make positive changes to the business, may become frustrated and leave. As long as the new, divested company is in the interim state, change is not really an option. The risk of losing staff at this juncture is very real but to a certain extent it can be managed. Ultimately having a quick and professionally driven demerger project would ensure the interim state is well-designed and ready to cope with any eventualities that may crop up. Also, the better the interim state is designed, the more quickly the new business will emerge from the shadows of its parent, reducing the risk of internal angst in the process.

The need for impartiality and professionalism in designing, managing and completing a demerger is obvious although the temptation to appoint internal project teams is not unheard of. This increases the risk by throwing emotion into the mix. The role of emotion in any business split (or even in M&As for that matter) is completely underestimated and can lead to poor planning and decision making and ultimately cost more and affect shareholder value greater.

The problem is that any internal appointment is not going to be the best team. Top executives and managers are not going to be put in charge as they would be needed to manage the business, keep it working and plan for the future, post-demerger. That leaves a less skilled, less motivated team, uncertain of their future, having to make decisions about which they would have limited experience. Even if a business has a top team of internal project managers in all likelihood they would have limited to no experience in demerging.

When faced with the complications of governance, setting up complicated external and internal communications processes, managing regulatory demands and designing complex stages of demerger activity, they would inevitably be found wanting. There is no substitute for experience when the future of the business and shareholder value is at stake.

Shareholders generally welcome demergers as they can and should improve a group’s transparency, sharpen its focus and please not only its existing shareholders, but also future investors. But there is one caveat. If a demerging business rushes headlong into a split, cuts corners and fails to recognise the complexity of managing the programme correctly, all the reasons for embarking on a demerger in the first place are thrown out the window.