March 1, 2023

Divestitures: The Spin-Off Alternative in a Turbulent Market

Companies are likely to see continued investor & activist pressure to divest non-core businesses in order to generate higher multiples for the parent or the divested business. This Skadden memo discusses some of the reasons that, in the current environment, companies that are looking to divest businesses may want to consider some form of spin-off transaction. Here’s an excerpt:

As 2023 unfolds, boards and management can anticipate even more calls to “unlock value” by separation. One catalyst is the capital markets, where equity multiples generally have declined but growth sectors and businesses with predictable cashflows sometimes command premiums. Another factor is increased shareholder activism in response to the uncertain outlook for corporate performance due to macro-economic factors like higher interest rates, inflation and hampered demand.

As boards and management teams evaluate business portfolios and potential separation transactions, they confront an M&A environment in which carve-out sales face headwinds, including mismatches between buyer and seller valuation expectations, increased financing costs due to higher interest rates and market dislocation, uncertainty around the macro-economic outlook and increasingly aggressive regulatory reviews.

Faced with such an uncertain environment, boards and management teams contemplating separations would be well-advised to consider carefully spin-off and similar transactions like Morris Trusts, Reverse Morris Trusts, split-offs and incubator joint ventures — transactions we will refer to collectively as spin-offs. If well designed, these can not only unlock value for shareholders, but leave the company with flexibility regarding the final structure, so they can pivot along the way in response to input from shareholders or changing market conditions.

The memo highlights a number of the benefits of a spin-off, including the tax advantages to the parent, the ability to better align compensation incentives for executives at both companies, the ability to control the timing of the transaction, and the flexibility to revise the transaction structure based on shareholder input.

Large cap companies that find themselves facing a need to divest a sizeable business should definitely consider the many potential advantages of a spin-off alternative, but based on the one Reverse Morris Trust deal I worked on in my not-particularly illustrious career, one more thing they should consider is that some of these deals can be more complicated than nuclear fusion.

John Jenkins