BREAKINGVIEWS-Corporate division generates problematic quotients

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Jeffrey Goldfarb

NEW YORK, Feb 4 (Reuters Breakingviews) - Simplicity is hard. For all the breezy and cavalier rhetoric that pushy investors, bankers and CEOs use to tout the benefits of breaking up companies, such efforts often fail to generate the anticipated or promised results. With a fresh wave of spinoffs in the works, it’s a good time to brush up on some harsh financial realities.

Whether for reasons related to ego, pay or simplistic growth, most bosses want to enlarge their empires, not shrink them. It’s also usually easier to buy a peer and hack out costs than it is to extract a business already tangled up inside a bigger enterprise. Although conglomerates have fallen out of favor, the ability to create value over the long term by splitting them into more narrowly focused operations sounds as dubious as the notion of one plus one making three in an acquisition.

There are plenty of historic examples for the latest crop of cleavers to consider. Over the past decade, CEOs worldwide have unveiled nearly $1.7 trillion of spinoffs and similar separations, where a unit started trading independently with a market capitalization of at least $1 billion. That’s according to Dealogic data which excludes divisional sales to corporate or private equity buyers. And plenty more are being teed up. Common rationales include streamlining operations, helping bosses focus, highlighting faster growing or more profitable divisions, and taking advantage of valuation discrepancies.

Pork producer WH Group 0288.HK last week spun off its U.S.-based Smithfield subsidiary for many of those reasons, as well as to draw geographic distinctions with its China business. Holcim HOLN.S, the Swiss building-materials maker, is doing the same with its North American arm. Cable operator Comcast CMCSA.O plans to create a new publicly traded company for a stable of networks including CNBC, while diversified manufacturer Honeywell International HON.O faces pressure from aggressive shareholder Elliott Investment Management to sever aerospace and defense from industrial automation. DuPont, the chemicals company that already divided itself into three units under Ed Breen’s stewardship, intends to splinter yet again.

The logic of such moves often sounds compelling, but the outcomes are mixed at best. Separations led to a blended excess return about 6% higher than for their respective sector indices, research conducted by Goldman Sachs and consultancy EY found. Morgan Stanley strategists discovered, after studying some 400 deals over two decades, that parent companies underperformed the market by about 8% and the spinoffs outperformed by more than 10%. It’s questionable, however, whether two years, which both Morgan Stanley and Goldman use as their cutoff point, is enough time to judge the performance. Since its 2015 debut, the S&P U.S. Spin-off Index has lagged the S&P 500 Index .SPX.

Further analysis, conducted by Breakingviews, presents additional cause for skepticism. The sample covered 60 chunky U.S. examples since 2015 where both parent and SpinCo are still publicly listed. More than a third of the time, one of the two companies has generated a negative total shareholder return, after factoring in reinvested dividends. In eight cases, both destroyed value following a split, as has occurred with Xerox XRX.O and Conduent CNDT.O since they separated in 2017 and Bath & Body Works BBWI.N and Victoria’s Secret VSCO.N since 2021.

Even some of the seemingly strong stories are inconsistent. For example, after e-commerce giant eBay EBAY.O capitulated in mid-2015 to billionaire investor Carl Icahn’s demand that it spin off PayPal PYPL.O, both companies trounced the broader market’s returns over the ensuing five years. The outperformance vanished, and then some, in the near decade through January, however. Hewlett Packard’s split in the same year as eBay’s represents a rare instance of both companies keeping up with the S&P 500 Index.

Despite the patchy results, aggressive hedge funds routinely turn to the breakup chapter in their playbooks to target corporate sprawl. Most recently, Elliott put $5 billion into Honeywell, the single biggest investment in its nearly five-decade history, as part of a campaign to convince boss Vimal Kapur to split the company. As part of its pitch projecting an up to 75% share-price boost over two years, the firm cherry-picked examples such as General Electric GE.N and United Technologies, now called RTX RTX.N, and “countless others that have found success through simplification.”

It’s fair to say that the breakups at GE and United Technologies have served shareholders well so far. The duo also capitalized on big uplifts in demand and valuation multiples for power providers like GE Vernova GEV.N and cooling-system installers such as Carrier Global CARR.N. Those conditions are hard to replicate, especially considering how long it often takes to pull apart the various components. Moreover, GE’s healthcare arm has generated lower returns than the S&P 500, as has RTX’s separated elevator business, Otis Worldwide OTIS.N.

Like the conglomerates themselves, it takes many smoothly moving parts to get a split right. They include the respective capital structures, management, division of assets and customer experiences. Finding the right fund managers and brokers to cover the two pieces can also be make or break. The prospect of a corporate cleanup always holds appeal, but it’s often hard to cut clearly through the spin.

Follow @jgfarb on X

(Editing by Liam Proud and Pranav Kiran)

((For previous columns by the author, Reuters customers can click on GOLDFARB/jeffrey.goldfarb@thomsonreuters.com))