Why do companies split up or spin out parts of their business?

Factual Questions
1

I read this morning that DuPont is under pressure to spin out the agricultural portion of its business, which is currently highly profitable. I’m not interested in this particular case (although GQ-style commentary is welcome); I would like to know about some very high-level reasons why companies decide to do spin out parts of themselves, and how this works as far as ownership/shares are concerned.

I did start with the google and here: Corporate spin-off - Wikipedia
but I’m still not quite wrapping my head around it.

2

It brings in more targeted investment dollars.

Look at it this way. Say a company sells widgets and also owns hotels. While the widget business is stable the hotel business is really doing well. Investors looking for hotel stocks may not be willing to dilute their shares with widgets but a “hotel only” stock looks pretty tasty.

So by spinning off the hotel section the parent company maximizes their stock sales, picks up more cash to use for growth and collects more profit from said actions.

3

Sometimes it’s so a business can focus on its core competency. In a specific case recently, I owned some stock in a company called Murphy Oil, largely a global oil and gas exploration and production company. They also owned a chain of gas station/convenience stores, mostly on real estate purchased from Walmart and sited in their parking lots.

The skills that make you a good convenience store owner aren’t necessarily skills that complement gas and oil exploration, so the stores were spun off. For every four shares of Murphy Oil (MUR) investors owned, they received one share of Murphy USA (MUSA), the spin off company. The stock price of the parent stock took a 25% hit, as value went with the spin off, but the spun off stock was worth what the price drop was on MUR, and MUR recovered nicely. All in all, a plus for stockholders.

4

In many ways, larger companies are much like clusters of related businesses under the same management. As such, companies can spin them off, sell them off or shut them down for various reasons.

Typically, companies get spun off when they’re profitable, but not part of the strategy of the larger company, or if they’re not as profitable as the rest of the company, but still profitable enough to stand on their own. The original company often retains most or all of the stock of the spun-off compnay. For example, Agilent Technologies was spun off from Hewlett-Packard because measuring and testing equipment was no longer part of HP’s core computer business, and HP wanted to concentrate on that business, so they spun Agilent off.

The idea is that HP understands computers and the computer business (debatable, but that’s for another thread), and wants to concentrate their time, effort and money on that. By spinning Agilent off and keeping a big chunk of stock, they basically let Agilent do what they do best, and let HP do what they do best (!?) and investors in both get a better deal.

In DuPont’s case, it looks to me like they’re being pressured to spin the agricultural portion of their business off so that investors can invest in it separately from the rest of the company which isn’t doing so well. In other words, DuPont doesn’t want to spin it off- they make a lot of money and see a lot of growth from it, but the investors want to invest in the part that’s making money directly, and not the part that makes paint, car wax, etc… that doesn’t make so much money.

That’s why DuPont is getting pressure from outside; if it was reversed, they’d be spinning it off, selling it or shutting it down themselves in order to keep themselves profitable and investable.

5

Not correct. In a spin off the shareholders of the company receive the shares of the spun-off company.

6

You’re right; I didn’t think my sentence through. I was thinking “original ownership” and put down “company” for some reason.

7

How is it determined how many shares go with which company? E.g. I own 100 shares in the original company, which spins out company B. I’m assuming I now have shares in both?

8

The company will usually hire an investment bank or M&A consulting firm to advise them on the valuation of the original company and the spun-off piece(s), and shares in the new company will be assigned proportionally.

These plans usually have to be approved by the shareholders, who have a right to challenge the conclusions of the advisor.

9

Having lived through a couple of corporate mergers and spinoffs it usually boils down to some combination of these:

One section of the company is stuck in a stagnant or declining market.

One section of the company is facing huge technological or environmental costs.

The company is facing huge legacy costs (think retirement benefits) and restructures to put those obligations in one section, then spin it off.

The company had previously gotten into a sector it now feels unable to compete in, and wants to cut its losses.

The government had decided the company is too big (ATT, Standard Oil, etc.) and must divest some parts of it to maintain a competitive market.

Monsanto went through an identical situation in the 1980’s and 1990’s. Originally a chemical company like DuPont, it sold its oil refineries to Tosco, turned its fertilizer operations into an independent company, got rid of its silicon wafer business because of low-cost overseas competition and finally divested itself of its original chemical/plastics business (and the environmental cleanup that went with it.) Nowadays Monsanto is mostly a seed/biotech company that still manufactures a few of its legacy herbicides.

10

I think it’s already been answered fully but just in case thinking about it from another perspective helps -

Spin-offs are in a general sense the opposite of a merger or acquisition. A key idea from corporate finance theory is that a firm should never merge or acquire another firm solely for the purpose of diversification.

Since we have efficient capital markets, an investor in Acme Corporation who wants to diversify into, for example, the boating industry, is always going to be able to go out and buy some shares of a boating company for much cheaper than Acme Corp could acquire or merge with a boating company.

The only way that merger/acquisition could be profitable for the firm is if there are also SOME kind of synergy beyond simply diversifying its business. Acme better be able to apply its expertise in making bath tubs to making boats, or some value adding reason, beyond just wanting to operate a broader range of businesses.

The same logic applies in reverse too - if they’ve got a business unit that doesn’t have any value adding synergy with their other operations there’s no value in keeping it all together, and possibly a lot of value in spinning it off.

11

Let’s use a simple example:

Company A has 1,000,000 shares outstanding with a value of $10 each, and a total corporate market value of $10,000,000.

It decides to spin off Company B. They will use an M&A consulting firm and an Investment Bank to do some analysis on the value, carve up the debt obligations, etc. But, in the end soemthing pretty simple happens. They need to decide how many shares to issue of the new stock. Let’s say in this instance they decide the Company that they’re going to spin-off is worth 2,000,000. They might choose to issue 200,000 shares or 100,000 or really any other number that is reasonable (you don't want it to be a penny stock or to have some really high /share because that can be a barrier to entry for some investors, plus it just looks funny).

So, let’s assume they decide to issue 400,000 shares.

Say you owned 100 shares of Company A. You would keep all 100 shares of Company A, and you would recieve 40 shares of the new Company B (you get a pro-rata amount).

If the company was correct about the valuation, you would expect that Company A is now worth $8,000,000, and with the same amount of shares outstanding, each share is now worth $8.

At a value of $2,000,000 and with 400,000 shares issued in Company B, each share would be worth $5.

So, your 100 shares of Company A would be worth $800 (1008) and your 40 shares of Company B are worth $200 (405). So, in this perfect scenario you end up with exactly the same amount of value as you had before.

Of course, it never works out this way in real life. The combined value is usually less or more than the starting value, which determines if it was a good idea or not (at least in the very short run in the eyes of the investment community).

There are lots of nuances that change things, but that’s the basic idea of it.

12

Again, in the case of my specific breakup, I initially had 200 shares of MUR, plus some odd shares earned as dividends, but call them 200. On August 30th they closed at $67.42. September 3rd they opened at $59.88, but I received 50 shares, plus a dab extra for the odd shares of MUSA. MUSA opened on September 3rd at $37.30, so I lost a little value there, from Friday’s close I lost around $545, but by the close on the third MUR had bounced to $59.80 and I was $350 to the good.

One interesting thing is, even though Murphy USA never existed until September 3rd, 2013, for tax purposes it is as if I owned the stock from the time I bought Murphy Oil, so even if I sold it the day it was created it was a long-term capital gain.

13

Very good points. Sometimes a spin-off is done to isolate liability. MegaConglom has a division called Cesspools-R-Us and the Gov’t is starting to snoop around. Let’s spin-off Cesspools-R-Us, so that the rest of MegaConglom is free of fines.

14

I used to work at a company called ARINC that did both commercial and military aviation/transportation products and services. We were privately held by the Carlyle Group, and when they wanted to sell us off, they found they had a problem, which is ‘Organizational Conflict of Interest (OCI)’. If you make a widget that you supply to the Government, they do not want you doing engineering or front office programmatic work for the widget because you have an OCI. The reason is because you could recommend designs that favored the use of your widget, or you could recommend that the Government carry a huge inventory and selectively fund the purchase of your widget. You could even get the Government to pay for future R&D for your widget to make it better, faster, stronger, cheaper, etc.

So ARINC was split into two pieces. All the defense services were split off and sold to Booz Allen Hamilton, which is a company that does defense front office programmatics, but did not do the back end systems engineering so it was a good complement. The commercial and products were sold off separately to Rockwell Collins. I have no idea how the sale went since the stock was privately held, but I suspect the shares for the two halves of ARINC were independently assessed and valued, then sold off to the highest bidder.

15

Strange things can happen when the market is asked to value individual pieces rather than a sum of the parts. During the heyday of the conglomerates (late 60s), there was a company called Ling-Temco-Vought (LTV) which acquired interests in all sorts of disparate businesses. At one point they bought out Wilson and Co, which itself was in three unrelated businesses - Wilson Sporting Goods, Meat Packing and Pharmaceuticals. LTV spun off each of those three divisions as a separate company, which traders soon nicknamed “Golf Ball”, “Meatball” and “Goofball” respectively. Each of the three wound up trading at a higher multiple than the original Wilson and Co, and LTV sold enough of the shares to pay off the creditors it had gone to for the buyout, while retaining a large chunk of each Wilson company. LTV eventually went bust as the “conglomerate” bubble burst, and they had to divest all their various interests, but the Wilson deal is often pointed to as emblematic of the era.

16

I’ll also mention that I worked for Bell Labs during the divestiture. THAT particular series of split ups and spin offs defies description.

17

I met a DCer recently who is or was doing some SETA work for DTRA who described a similar situation to me. I don’t recall what companies were involved.
Thank you everyone, this has been illuminating.

18

For a hypothetical, vertical integration might be a benefit. Maybe Acme is in the maritime transportation business (i.e. it ships stuff for profit), or it needs to regularly ship cargo or personnel by sea for internal purposes (maybe they make glass in a facility in Florida that then has to be shipped to a facility in Puerto Rico to be mounted to frames made locally, then shipped to New York to be sold as windowpane assemblies). If Acme made its own ships, it wouldn’t have to worry so much about being beholden to shipbuilders and their prices and paying through the nose for unneeded features on the X-4455 SuperShip.

19

That would be the synergy or value addition that Fuzzy Dunlop was talking about.

He was talking more about why LTV (a maker of missiles and aircraft originally) would have a sporting goods manufacturer as part of its portfolio, and the answer is that unless having that company helps them in their manufacturing of missiles and aircraft, it doesn’t make sense. They could just as easily invest in the sporting goods company without the trouble of owning and running them, and more importantly, they have more flexibility and less risk by investing rather than owning outright and running them.

20

Years ago, my employer split off the IT department as a separate Big Bank Services Corporation to ease regulatory and certification issues - the guy stringing network cables in an office doesn’t need to know about money laundering, for example. Keeping the tech people with no customer contact away from the money people made for roughly 15,000 fewer people that needed to be trained in financial matters. (You thought I was kidding about Big Bank?)

In the past decade, the services company was re-absorbed as part of the corporation as a whole as the changing regulatory environment made the division pointless and it’s easier to sign off on something saying all employees have been trained in securing customer information, large cash transactions, the PATRIOT Act, etc. than to explain why this group wasn’t trained.