Equity carve-outs: A new spin on the

corporate structure
Patricia Anslinger,
Dennis Carey,
Kristin Fink, and
Chris Gagnon
Pat Anslinger and Kristin Fink
are consultants in McKinsey’s
New York office. Dennis Carey
is co-founder of the Directors
Institute of Wharton and
managing director of Spencer
Stuart Executive Search
Consultants. Chris Gagnon,
formerly a principal in the New
Jersey office, is principal of Blue
Capital Investment. Copyright
© 1997 McKinsey & Company.
All rights reserved.
he purpose of a corporate center is to do for the
T subsidiaries what they cannot do eƒfectively for
themselves. Many structures serve this purpose:
operating companies, multibusiness companies, holding
companies, conglomerates, and even investment firms
such as Berkshire Hathaway – all are diƒferent ways for
a single, central parent to deliver value to its business
units. The newcomer to the list is the equity carve-out.
Like its predecessors, the carve-out enables a subsidiary
to draw on the wisdom, experience, and practical assistance
of the executive center. But it also oƒfers something new:
a degree of independence that appears to foster innovation
and growth.
An equity carve-out is the sale by a public company of
a portion of one of its subsidiaries’ common stock
through an initial public oƒfering (IPO). Each carved-out
subsidiary has its own board, operating CEO, and financial
statements, while the parent provides strategic direction
and central resources. As in any other corporate structure,
the parent can provide executive management skills,
industry and government relationships, and employee
plans, and perform time-consuming administrative

ABOUT THE RESEARCH

W e used the Securities Data Corporation
database to examine all US domestic
equity carve-outs from 1985 to July 1996 in
which the parent retained at least 50 percent
of the subsidiary shares and had annual
revenues of at least $200 million. We then
refined the sample using Compustat, Bloomberg,
and news reports to eliminate certain
subsidiaries such as financial institutions,
foreign companies listed via ADRs, companies
that were too young to evaluate, or those for
which data were unavailable.
A subset of the sample was then created,
comprising companies that had completed
multiple equity carve-outs and could be said to
view them as an integral part of their operating
strategies (see Appendix on page 172
for a detailed description of the companies
in this subset and how they performed).
We interviewed executives from four out
of five of these companies.
How the sample was compiled
350 Securities Data Corporation database
–17 Financial buyers
–44 Financial institutions
–29 ADRs, foreign parents
–24 Spin-offs
–2 Reverse carve-outs
–52 No record in Compustat
–13 Price discrepancies
–50 Too small; inactive companies
119 Sample

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functions, freeing the subsidiary’s CEO to concentrate

on products and markets. What is diƒferent is the way in
which the role of the corporate center is clearly spelt out
in contractual agreements.
A number of companies have chosen to spin oƒf a single
subsidiary in this manner. A smaller group, including
Thermo Electron, Enron, Genzyme, Safeguard Scientifics
and, more recently, The Limited, have chosen the carve-out
as their basic organizing structure, repeatedly selling stakes
in their business units. The results are striking.
We examined the performance of US equity carve-out
subsidiaries from 1985 to 1995, in cases where 50 percent
or more of each subsidiary’s shares were retained by the
parent. (We were interested only in those companies where
the parent remained an operating center, not a loosely
aƒfiliated holding company.) Over a three-year period,
the subsidiaries in this sample showed average compound
annual returns of 20.3 percent – 9.6 percent better than
the Russell 2000 Index (Exhibit 1). Those companies that
Exhibit 1

Overall performance of subsidiary carve-outs

Average shareholder return Subsidiary carve-out sample Russell 2000 Index

1 Year 2 Year 3 Year

Compound annual return 34.2 25.2 20.3
11.2 11.4 10.7
23.0 13.8 9.6
Compound median return 8.9 8.2 6.6
10.3 12.4 12.2
Sample size 119 105 76

Exhibit 2

Performance of companies that repeatedly carve out

Average shareholder return Parent Carved-out subsidiaries Russell 2000 Index

1 Year 2 Year 3 Year

Compound annual return 35.3 38.2 31.1
82.1 51.1 36.8
11.0 10.8 10.2

repeatedly sold stakes in subsidiaries fared even better.

* Parent company returns in
the larger sample were not
evaluated as many only spun
out a single, small business,
whose performance was
unlikely to have a significant
effect on the parent.
Three years aƒter the carve-out, their subsidiaries showed
annual returns of 36.8 percent. The parent companies
themselves experienced average annual shareholder returns
of 31.1 percent (Exhibit 2).*
The results suggest that equity carve-outs are an eƒfective
way for companies to exploit growth opportunities and
increase shareholder value. Safeguard Scientifics, for
instance, has spawned six new companies since 1985,
with revenue growing from $66 million then to $1.9 billion
in 1996.

166 THE McKINSEY QUARTERLY 1997 NUMBER 1

So what is it about a carve-out that promotes such growth?
The answer appears to lie in the changed relationship
between the corporate center and the business unit, and
the eƒfect this has in three important areas: corporate
governance, human resources, and finance.

Corporate governance
More value from the corporate center. Many corporate
centers oƒten do little more than shadow-manage business
units; and frequently they suboptimize the plans of
individual business units in the search for intra-company
synergies. Carve-outs prevent these abuses. The agreements
between parent and subsidiary are communicated to the
subsidiary’s shareholders through the oƒfering prospectus.
If the cost of the services the parent provides (typically 1
to 2 percent of revenue) is not deemed worth the benefits,
then the subsidiary’s board has a responsibility to minority
shareholders to renegotiate the agreement or bring the
services in house.
The corporate center is therefore forced explicitly to
add value by answering to an outside constituency of
shareholders. No transaction will be tolerated, either
between the subsidiary and its parent or the subsidiary
and another business unit, that is not in the economic
interests of all concerned.
Stock market scrutiny. Business units that are 100 percent-
owned are the sole responsibility of their parents, and are
thus the subject of countless corporate reviews, meetings,
and reports. Carve-outs, however, are under the direct
scrutiny of investors and analysts who constantly measure
them against other companies. Far from fearing such
attention, CEOs of companies that conduct carve-outs
welcome it as a means of monitoring (and improving)
performance. ‘’We outsource that stuƒf to the market,’’ says
John Hatsopolous, CFO of Thermo Electron. “They’re
better at it than we are and we get them to do the work.”

Human resources
High motivation. Linking pay and business unit
performance is one of the most diƒficult issues corporate
boards face, and they seldom provide the kind of incentives
that encourage outstanding performance. In carve-outs,
however, corporate boards can use the market to align pay
closely to performance, awarding managers stock in their
own carved-out units rather than cash bonuses and/or
parent company stock.
The payback is clear: increased entrepreneurialism,
which benefits the parent company, the subsidiary, and

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* Spencer Stuart discovered
that out of 41 CEO assignments
over an eight-month period,
65 percent were filled by
executives who were number
two in their previous companies,
and who were motivated by the
desire to run an independent
operation.
168 THE McKINSEY QUARTERLY 1997 NUMBER 1
top managers alike. As Victor Poirier, CEO of Thermo
Cardiosystems (a carve-out from Thermo Electron),
points out: “What you do is represented in the stock price.”
In fact, many of the subsidiary CEOs we interviewed saw
their compensation more than double during the first year
of independent operation.
John England, a principal at compensation firm Towers
Perrins, believes the prospect of higher compensation is a
key motivation for executives in carved-out subsidiaries.
‘’With carve-outs, companies have a once-in-a-lifetime
opportunity to develop a new executive and board
compensation program. They can clearly indicate to
investors, executives, and other employees that performance,
ownership, risk, and reward are bound together. It’s exciting
to work with these new-born companies.’’
Money is not the only incentive. The carve-out structure
also responds to the psychological need of high-performing
executives to be autonomous. Business unit presidents
are no longer bit players in a billion-dollar company,
they are CEOs.
Concerns that CEOs’ ownership of subsidiary stock
will drive them to be too independent, at the expense
of the group, can be dealt with by compensating them
with a balance of subsidiary and parent stock. Thermo
Electron rewards its subsidiary CEOs with a 40/40/20
package: 40 percent subsidiary stock, 40 percent parent
stock, and 20 percent stock in a diƒferent, though
related, business unit.
Talent retention. Companies sometimes lose their most
talented people because they cannot oƒfer them enough
independence.* Before Thermo Electron embarked on its
carve-out strategy, several key executives were lured away
by venture capitalists who promised them the chance to
exercise their entrepreneurial talent by running their own
operation with their own board of directors. Since then, not
a single key executive has been lost. Safeguard Scientifics
has had a similar experience: the company has not lost a top
executive in the past five years.
Equity carve-out structures actually oƒfer executives a nice
tradeoƒf between risk and reward. The CEO who is lured
away by a venture capital firm to start a new company
probably faces a tougher initiation than the CEO of a
subsidiary carve-out who has strong support from the
parent company.
Succession planning. Subsidiary carve-outs serve as
breeding grounds for candidates who might succeed senior
executives in the parent company. Here, subsidiary CEOs
get the chance to prove their business acumen and ability to
work with their own board of directors. In discussions with
GTE and SmithKline Beecham we learned that they
consider board experience important in identifying
internal candidates for succession.

Finance
Funding for new ventures. The stock market’s close
scrutiny of margins and earnings can inhibit investment
in growth, which means new ventures within corporations
are sometimes underfunded. Equity carve-outs give parent
companies in this position the chance to fund projects that
might otherwise drain earnings. While the parent company
includes the subsidiary’s equity on its balance sheet, the
income statement contains only a proportion of the
subsidiary’s expenses (51 percent ownership by the parent
company would record 51 percent of the subsidiary’s
expenses).
‘’Subsidiary carve-outs allow us to develop new businesses
we would not otherwise have developed,’’ states John Wood,
CEO of Thermedics, a quality assurance and inspection
product company. Wood spun out Thermo Cardiosystems,
which makes implantable heart-assistance devices, in 1989.
Cardiosystems has since achieved compound annual returns
for shareholders of 66 percent.
New investors. Because carve-outs enable investors to
buy shares in distinct businesses, they can attract a new
constituency of shareholders. Investors can own shares in
food company Nabisco, a carve-out of RJR, without owning
shares in the parent tobacco company, for example. Boise
Cascade, an integrated paper and forest products company,
attracted 26 major new institutional investors when it
oƒfered a minority interest in Boise Cascade Oƒfice
Products, a direct supplier of branded and private-label
oƒfice furniture and supplies.
Carve-outs can also increase analysts’ coverage of the
parent company and its various subsidiaries, which in turn
can increase demand for stocks. Safeguard Scientifics says
carve-outs have prompted new interest in the company
from top-tier, international market analysts, and that it now
receives more requests for company literature in a month
than it previously did in a year.
New capital at attractive prices. Traditional financial
theory suggests the market will value a project or
business the same, irrespective of whether the parent
or the subsidiary is raising funds. Many CEOs we
interviewed, however, felt the subsidiary could oƒfer
stock at more attractive prices. Although we cannot
test this opinion empirically, it is possible that when a

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TAX AND ACCOUNTING CONSIDERATIONS

T he decision on how much to carve out will
depend on accounting and tax advantages.
If the parent retains 80 percent it can be
consolidated for tax purposes and subsidiary
dividends are fully deductible. A stake greater
than 50 percent allows a consolidation for
accounting reasons .
The parent or subsidiary can receive the
proceeds of the IPO. If the parent sells shares in
the subsidiary, it is considered a taxable gain or
loss. If the subsidiary sells primary shares, it is
generally treated as a non-taxable event, even
if the proceeds of the shares are used to repay
loans to the subsidiary from the parent.

What to take into account

Stake retained by parent
<20% 20% to <50% 50% to <80% 80%+
Parent consolidates subsidiary for No No Yes Yes
accounting purposes
Parent consolidates subsidiary for tax No No No Yes
purposes*
Parent can distribute/alter remaining shares No No No Yes
in a tax-free distribution (section 355)
Dividend received deduction on subsidiary 70 80 80 100
dividends to parent
Parent reports its equity investment in the Cost Equity Full Full
subsidiary for accounting purposes method method consolidation consolidation
* Tax consolidation is based on controlling 80% of the subsidiary voting shares based on vote and value

subsidiary does an IPO, analysts take the time to evaluate

its growth and profitability fully; whereas when the parent
goes to the market, its performance overshadows the
smaller unit’s potential.

Why doesn’t everyone do equity carve-outs?

Any company undertaking an equity carve-out should
realize that the act itself is no guarantee of success.
The median compound annual return of our sample group
was only 6.6 percent, compared with 12.2 percent for the
Russell 2000 over a three-year period. In other words,
while some companies do extremely well from carve-outs,
others do not.
In analyzing the also-rans, we discovered that not all the
carve-outs were done to spur performance: some parent
companies wanted to distance themselves from slower-
growing businesses. Others carved out units but failed to
give them the strong management teams they needed; still
others simply failed to take advantage of the new structure,
applying the same old compensation and management
practices as before.
Corporations must also realize that an equity carve-out
will not suit everyone. It makes sense only under certain
circumstances, when subsidiaries can be separated easily

170 THE McKINSEY QUARTERLY 1997 NUMBER 1

from the parent and other business units without creating
huge transfer-pricing issues, and when the subsidiary has
good prospects.
Companies also have to be prepared to deal with extra
complexity and costs. Contractual agreements mean that
transfer pricing, co-marketing, and technology sharing
between the subsidiary and the parent or other subsidiaries
have to be scrutinized by each board, which can be diƒficult
and time-consuming. In addition, a carve-out duplicates
administrative costs, and the cost of a subsidiary’s debt is
likely to rise once its assets and liabilities are separated
from the more secure parent.
Successful equity carve-outs also require subsidiary
management teams to work cooperatively with the
corporate center. ‘’The best, most secure management
teams will always take advantage of all the help they can
get,” says Dave MacLachan, CFO of Genzyme. “Weaker,
more insecure managers will always push for more
independence than they are ready for.’’ Some of the
carve-out companies we examined seemed to have
stumbled and failed on this very issue.
Finally, it has to be remembered that an equity carve-out
is not a substitute for selling a business unit that should
be discarded. It is instead a way of keeping businesses
together that can create value together, but under a new,
more vital structure.
Done properly, and under the right conditions, carve-
outs oƒfer an exciting opportunity to increase returns
to shareholders. In the 1990s, innovation and growth are
increasingly tied to specific employees who are mobile,
and who demand a considerable share of the value they
help create. To perform well in an environment of
specialization, increased competition, and diminishing
product life cycles, those individuals need the power
to act quickly and independently. At the same time,
globalization and shared resources such as reputation
demand a degree of coordination.
Carve-outs can help address all these issues. They foster
many of the performance advantages found in independent,
agile businesses, but they do not forfeit the opportunity to
profit from synergies among business units, or from the
wisdom and experience of the executive center.

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∫ ∫ ∫ ∫ APPENDIX

Performance of subsidiaries of companies that repeatedly carve out

Parent
Subsidiary carve-out* – IPO date Parent March 97, March 97, Average compound
ownership subsidiary subsidiary annual return
Thermo Electron percentage† market value as
Measuring and controlling devices value a percent
Market value, March 97 – $5,187.4 million $ million of parent† 1 Year 2 Year 3 Year
Thermedics Inc. – 08/83
Biomedical products 51 683.1 7 23.7 43.0 111.6
Thermo Instrument Systems – 08/86
Monitoring and process control instruments 86 3,033.5 50 56.6 37.2 42.9
Thermo TerraTech Inc. – 08/86
Environmental services 81 165.2 3 –16.9 –3.9 62.0
Thermo Power Corporation – 06/87
Refrigeration systems, engines, cogeneration 63 84.3 1 –47.2 –30.3 –2.0
Thermo Cardiosystems – 01/89
Heart-assist devices 55 88.5 1 97.4 87.3 63.0
Thermo Voltaic Corporation – 03/90
Electromagnetic testing instruments 59 102.5 1 413.4 83.0 65.5
ThermoTrex Corporation – 07/91
X-ray systems 51 475.2 5 28.3 18.1 16.6
Thermo Fibertek – 11/92
Paper recycling, papermaking systems 81 680.2 11 61.1 34.6 50.9
Thermo Remediation – 12/93
Soil and waste fluids recycling services 69 99.5 1 29.4 24.9 NA

ThermoLase – 07/94
Personal care products 65 554.5 7 600.0 201.4 NA

Thermo Ecotek Corporation – 01/95

Combustion technologies, clean fuels 83 356.5 6 50.0 NA NA

ThermoSpectra Corporation – 08/95

Imaging and measurement instruments 72 174.3 2 NA NA NA

Trex Medical Corporation – 06/96

X-ray and related apparatus 91 343.1 6 NA NA NA

ThermoQuest Corporation – 03/96

Analytical instruments 94 732.8 13 NA NA NA

Enron – Petroleum
Market value, March 97 – $9,987.0 million
Enron Oil & Gas – 10/89
Crude petroleum 86 3,354.5 29 36.0 7.7 16.2
Enron Global Power & Pipelines – 11/94
Engineering services 58 688.9 4 7.0 NA NA

Genzyme Corporation – Biotech

Market value, March 97 – $1,697.6 million
Genzyme Transgenics – 07/93
Therapeutic/diagnostic products and services 72 155.8 7 –57.0 –17.7 –20.7
Genzyme Tissue Repair – 12/94
Tissue repair products 67 145.3 6 NA NA NA

Limited – Retail
Market value, March 97 – $5,387.4 million
Intimate Brands – 10/95
Intimate apparel and personal care products 84 5,081.6 79 11.7 NA NA
Abercrombie & Fitch – 9/96
Casual apparel 85 133.8 2 NA NA NA

Safeguard Scientifics – Information technology

Market value, March 97 – $633.8 million
Tangram Enterprise Solutions – 02/88
Prepackaged software 72 76.4 9 11.0 –46.2 –35.9
Cambridge Technology Partners – 04/93
Systems integration, consulting services 21 1,059.8 35 45.0 60.9 85.7
Coherent Communications – 06/94
Telecommunications technology 37 258.2 15 253.0 111.5 NA
USDATA – 06/95
Software, hardware, design consulting 21 49.7 2 3.0 NA NA
Integrated Systems Consulting Group – 04/96
Systems integration, application development 11 75.9 1 NA NA NA

* Parents have had at least one subsidiary carve-out which they either bought back or spun-off
† Market values are approximate since share ownership may change over time
NA Not available
Source: Annual reports; Bloomberg; Compustat

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