Corporate separation strategies like carve outs are complex but can be a catalyst for transformation and growth.
Following the global financial crisis, companies embraced the bigger is better philosophy by diversifying their portfolios, engaging in mega-merger activities throughout the past decade. This resulted in today’s complex corporate portfolios where approximately two-thirds of companies listed on the S&P 500 have three or more business segments with over $500 million in revenue.
However, recent financial market uncertainty, coupled with challenging operating conditions and high interest rates, has led companies to re-evaluate their portfolios and pursue corporate separations to position their businesses for success. Markets are increasingly valuing companies that “shrink to grow” and focus on their core businesses. Increased separation activity is evident across all industries, especially industrials and health care.
- Tile 1 shows 66% of the S&P 500 have three or more segments with >US$500m of revenue, driven in part by 10 years of mega-merger deals.
- Tile 2 shows a bar graph of number of announced transactions between years 2018 though 2022. 2022 shows the most transactions in that duration at 30%.
- Tile 3 is a donut chart depicting the separation of transactions by US (69%) and non-US (31%).
- Tile 4 indicates 6+% excess returns for companies executing separations vs. index.
When we decide to undertake a separation, we do it for the long-term strength of the company. Some people spin to get rid of a weak link. I never do that. I want NewCo to be the best in the industry. I want to give them a chance to rock and roll.
As leading advisors in this space, Goldman Sachs and EY have collaborated to develop comprehensive insights on spin-offs and demergers — what are corporate separations, why would a company consider separating, when is the optimal time to execute, and most importantly, how can a company maximize value in a separation? Our research combines quantitative analysis of more than 160 global transactions from 2012–22 where the business being separated had a market cap greater than $1b, as well as first-hand interviews with some of the world’s top executives who have prior experience with corporate separations.
Corporate separations are complex but can generate significant shareholder value and, in many cases, outperform the market. We measure the success of separations in terms of total shareholder return across the two resulting businesses, RemainCo and NewCo. Our analysis shows that when corporate separations are executed well, they can lead to an excess blended return of roughly 6% from announcement to two years post-close as compared with their respective company’s sector index.
While long-term outperformance is not guaranteed, the strategic vision and decisions executives make pre-separation are critical. There are five areas where companies will want to focus their efforts to maximize long-term value for shareholders.
Corporate separations should be used as catalysts for NewCo and RemainCo to reinvent their operations. ParentCos should implement these initiatives rather than take the more expedient, but less optimal “clone-and-go approach.” Pursuing high-value and complementary mini-transformations can impact growth and gross margins.
Corporate separations provide an opportunity for leadership teams to focus their attention on the priorities of the specific business, especially for NewCo. NewCo leaders should be announced early in the separation process to give them sufficient time to shadow ParentCo executives on public company responsibilities. This enables the NewCo team to be well-versed on leading a company and effectively communicating the strategy as it readies its debut in the public market.
A corporate separation allows each business to have its own access to capital and the ability to strategize around capital allocation priorities. Given the generally different financial profiles and operating stages of the two businesses, one company typically focuses on margin improvement post-separation (RemainCo) and the other focuses on revenue growth (NewCo). RemainCo tends to focus on increasing its return of capital post-separation, while NewCo increases its allocation toward investment into organic and inorganic business opportunities, including M&A. Outperforming NewCos spend a greater proportion of total capital on investing in growth as compared to those that underperformed.
As in any large-scale corporate program, separations will take time and cost money. Our analysis of previously completed transactions shows that over 60% took longer than nine months from announcement to close; they can also entail one-time costs between 1–6% of NewCo equity value. Our analysis shows no significant correlation between time from announcement to close and post-separation performance. Companies should balance timeline commitments and costs while providing NewCo time to implement improvements that are the very source of value creation.
Corporate separations can bring significant uncertainty. This makes regular, transparent communication across all shareholders, employees, customers and suppliers essential to building understanding and belief in the program. Additionally, communicating the equity stories of both businesses to key stakeholders is imperative to support NewCo on its path to becoming a newly public company, and for RemainCo to rebrand itself and meet with both existing and potentially new investors.
Overall, corporate separations continue to be a preferred lever to unlock value in any industry. The recent uptick in such transactions reflects an acknowledgement of the outperformance from recent corporate separations as well as an effective way to circumvent tumultuous buyer and market conditions. Executives that understand the time and cost involved and who can build consensus with their strategic vision are well-prepared to embark on the separation journey.
By using separation strategies like carve outs as a catalyst for transformation, companies can greatly increase the odds of creating long-term value and outperforming in the market. Download the full report to discover why the market is rewarding the shrink-to-grow model.
The rise of corporate separations
This podcast features Sharath Sharma of EY and David Dubner of Goldman Sachs.
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