Reason 3: If RemainCo says unlocking value is the spin-off rationale, the market expects leadership to walk the talk
In many spin-off announcements, we find that the primary spin-off rationale provided by management includes opportunities to further improve RemainCo. The following are the three most common opportunities cited by leadership:
- Increasing focus on RemainCo’s core strength
- Eliminating conglomerate discount
- Developing a business-appropriate capital structure for RemainCo
When companies communicate such commitment to ensure success for both SpinCo and RemainCo, the market reacts positively. The same analysis shows company stock prices experience an increase on the day of announcement 78% of the time, with an average share price increase of 3.5%.4
However, as a spin-off progresses and the negative impact on RemainCo starts becoming more evident, the market becomes increasingly inquisitive about RemainCo’s future. Shareholders seek guidance from management in every interaction, formally and informally, to confirm that the management is aware of challenges and has a clear plan to identify and execute value creation initiatives.
An analysis of market calls, investor meetings, analysts’ reports and news coverage of spin-offs5 reveals that in almost every interaction, questions were asked about RemainCo’s future and management’s plan to transform the business. The most common questions asked were related to:
- Stranded costs
- One-time separation costs
- Capital structure impact
- RemainCo transformation road map
The analysis also revealed that the market becomes more anxious about RemainCo as the spin-off date approaches.
Based on market expectations and the original intent of a company to protect RemainCo’s interests, it is imperative for management to walk the talk and take steps to ensure RemainCo’s success. Failure to do so not only disappoints the market, but also makes it more difficult for management to bring about big changes later in the process.
Reason 4: If separation decisions made during a spin-off are managed carefully, it can substantially help reduce value erosion for RemainCo
One of the biggest reasons companies don’t restructure RemainCo is the fear of overburdening the organization with the parallel activities of executing a major spin-off and undertaking a substantial restructuring effort. However, critical separation decisions related to the spin-off can have a substantial negative impact on RemainCo, making the spin-off the most appropriate time to stabilize and restructure RemainCo.
Specifically, there are five critical junctures in any spin-off process with which RemainCo should align.
1. Operating model decision
The proposed changes to SpinCo’s operating model on Day 1 and future state can impact RemainCo’s operating model. If needed, the RemainCo operating model should be redesigned at the same time to reduce value erosion.
2. Organizational design and talent selection
Management should ensure there is no cherry-picking of talent, and both SpinCo and RemainCo are staffed with the right talent to ensure future success.
3. Transitional services agreement (TSA) structure
While TSAs can allow RemainCo to postpone some stranded costs, it also ties up RemainCo with people and other resources providing these services, thereby delaying any transformation effort. The right balance should be achieved.
Spin-offs can create uncertainty among various stakeholders (employees, customers, investors) for both SpinCo and RemainCo. Companies cannot afford to communicate with only one side and not another.
5. Day 1 execution
Due to substantial changes in the operating model, the disruption to the business can be high on the day of close for both SpinCo and RemainCo. Leadership on both sides should closely monitor and manage any risk to business continuity on Day 1.
When companies spin off a substantial portion of their business, their intention is always to make both SpinCo and RemainCo successful. However, the pressure to complete the spin-off on time and the complexity involved may result in leadership waiting too long to focus on RemainCo. Companies should realize that critical decisions taken to separate SpinCo can have a substantial impact on RemainCo, making the spin-off the most appropriate time to plan for RemainCo restructuring. Furthermore, the market, albeit apprehensive about potential stranded costs and dis-synergies from a spin-off, demands clear guidance regarding RemainCo’s future. Companies that leverage the momentum built to execute a major spin-off can rally its people to execute the RemainCo transformation in parallel, which will often be richly rewarded by investors.