Demergers are in fashion right now and here are three spin-offs to keep your eyes on.
We Brits call them demergers, but Americans call them spin-offs. But whatever you call them, breaking up a company into smaller chunks is quite fashionable right now.
At first sight it is unclear as to why breaking up a company into smaller bits can create value. Some cynics say it is just a ploy by investment bankers to make more money for themselves. And they may be right. It seems that when shares are rising merchant bankers like to encourage their clients to issue shares to acquire businesses. But when markets are either flat or falling, bankers, who earn their fees from corporate activity, will instead turn to demergers!
That said, demergers can make sense if a company can benefit from a break up. Consider Severn Trent
(LSE: SVT)
, which announced that its rubbish businessBiffa will be floated this year. To all intents and purposes, the two businesses operate in completely separate markets -- Severn Trent Water is a regulated business while Biffa operates in a competitive waste market. But in my view, investors have been increasingly attracted to pure-play water companies because of their stable revenues. Consequently, a demerger makes good sense.
GUS
(LSE: GUS)
is another company that has chosen to go down the demerger route. It will split its UK retail and Experian credit-checking units next month. Following the demerger, the UK retail business, which will include Argos and Homebase, will be renamed Home Retail Group. As I see it, there was never any real logic in keeping the two businesses together in the first place. So both businesses may perform better if they are kept apart. Additionally, investors will have a clear choice between a mundane retailer or a fast-growing but potentially cyclical credit-checking business.
Sticking with retail, WH Smith
(LSE: SMWH)
has recently split into two separate entities. Smiths News
(LSE: NWS)
is the news distribution business and wholesales newspapers and magazines. Meanwhile, WH Smith
(LSE: SMWH)
is a retailer of books, newspapers and magazines. Curiously, WH Smith seemingly never saw what others could see, namely a conflict of interest between its wholesaling and retailing divisions. But now Smiths News will be able to service other newsagents who were perhaps previously standoffish because they were seen as direct competitors to WH Smith.
In my view, demergers generally make good sense because they allow management the freedom to develop its own ideas. It also allows a company to deploy resources without having to compete with other divisions within the business.
Interestingly, in a study of 48 European demergers in 2002, the London School of Economics found that demergers can be beneficial to shareholders both at the time of the announcement and in the following two years. They cited organisational improvements, capital market improvements, improvements in corporate governance and bondholder expropriation as possible reasons for the improvements. But I think it's because it is just common sense!
More on this topic:Profiting From Spin-Offs | Spin-off Success Stories | Divide And Conquer
