By Sharath Sharma, Michael Swanson, David Dubner, and Asmita Singh
Following the global financial crisis, companies embraced the bigger-is-better philosophy by diversifying their portfolios, engaging in megamerger activities throughout the past decade. This resulted in complex corporate portfolios: today, 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, challenging operating conditions, and high interest rates have led companies to reevaluate their portfolios and pursue corporate separations to position their businesses for success.
Corporate separations are a catalyst for transformation and growth. Markets are increasingly valuing companies that “shrink to grow” and focus on their core businesses. Increased separation activity is evident across all sectors, especially industrials and health care.
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?
As leading advisors in this space, Goldman Sachs and EY have collaborated to develop comprehensive insights on spin-offs and demergers. Our research combines quantitative analysis of more than 160 global transactions from 2012 to 2022 in which the business being separated had a market cap greater than $1 billion, as well as interviews with some of the world’s top executives who have 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 the time of announcement to two years post-close, compared with their respective companies’ sector index.
While long-term outperformance is not guaranteed, the strategic vision and decisions executives make pre-separation are critical. There are five areas in which companies will want to focus their efforts to maximize long-term value for shareholders.
- Reimagining NewCo and RemainCo during the execution.
A corporate separation should be a catalyst for NewCo and RemainCo to reimagine their operations. A “ParentCo” should implement such an initiative rather than take the more expedient but less optimal “clone and go” approach. A best practice is to pursue high-value and complementary mini-transformations to boost growth and gross margins.
- Deriving benefit from dedicated management focus.
A corporate separation provides 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 ensures that the NewCo team is well versed in leading a company and effectively communicating the strategy as it readies its debut in the public market.
- Tailoring capital priorities to the unique profiles of the assets.
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 mergers and acquisitions (M&A). Outperforming NewCos spend a greater proportion of total capital on investing in growth compared with those that underperform.
- Managing the separation.
Like any large-scale corporate program, separations take time and cost money. Our analysis of completed transactions shows that over 60% of transactions took longer than nine months from announcement to close and entailed one-time costs of between 1% and 6% of NewCo equity value. We found 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.
- Communicating with stakeholders.
Corporate separations can bring significant uncertainty, so frequent, transparent communication across all shareholders, employees, customers, and suppliers is 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 the number of these transactions reflects that the outperformance of recent corporate separations has shown them to be an effective way to circumvent tumultuous buyer and market conditions. Executives who understand the time and cost involved and who can build consensus with their strategic vision are well prepared to embark on the separation journey.
David Dubner, Goldman Sachs Global Head of M&A Structuring
Asmita Singh, Goldman Sachs Vice President, M&A Structuring