Pros and Cons of Splits and Divestitures
Fenwick & West mergers and acquisitions co-chair Doug Cogen was extensively quoted in a Financier Worldwide magazine cover story on the pros and cons of corporate splits and divestitures.
“Divestitures are driven by a number of factors, united by the view that corporate splits drive increased shareholder value than if the two businesses were to remain together," Cogen said. “Improving managerial focus on each business is a key driver, and numerous studies have found that spun-off stocks consistently outperform the wider market, presumably because their management team is able to completely focus on improving operations in the spun company. It is also often the case that one part of the business is growing faster than the other, or is more profitable. In many cases, these are not the same business, so separating them can place the ‘right’ type of investor – growth vs. cash flow – with the right investment.”
The article notes that although “shrinking to grow” is now regarded as an agile strategy to drive value and move a company into the future, splitting a business can still be seen as a sign of weakness.
“In some cases, a divestiture is unwinding a previous acquisition, so some commentators are quick to cite spin-offs or sales as a sign of weakness," Cogen said. "But the business landscape evolves, and separating previously linked businesses can unlock value in a number of ways.”
He added, “Executive focus on a single business can drive tremendous value in the years following a spin. A divestiture can also more closely link the cash bonuses and equity incentives of each business’ employees, resulting in improved retention and incentivization. Another key driver is that in some cases the spun business can access customers that are competitors of the parent, as exemplified by Paypal.”
But divestitures contain a number of unique challenges that must be anticipated, he continued.
“Virtually all companies find that the divestiture process is far more difficult than an acquisition," Cogen explained. "The preparation and audit of carve-out financials for the separated business can often take a year of steady work. Shared functions, such as sales and marketing, finance and human resources need to be allocated between the businesses. Intellectual property used in both businesses needs to be allocated, often with licenses running back to the party not receiving ownership. In many cases, customer and vendor contracts cover both businesses’ product lines. Real estate and capital equipment needs to be allocated. Employees need to be assigned to each business, and it is critical not to see people as ‘winners’ and ‘losers’ in this process. These employees’ equity awards also need to be adjusted for the transaction.”
The full article is available through the Financier Worldwide website.