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Summary of

BREAK UP!

How companies use spin-off to gain focus and


grow strong

David Sadtler
Andrew Campbell
Richard Koch
Introduction

$1 Trillion on table – Breakup experience till date shows that there will be an
increase of share price by 20%. By breaking up 100 MBC’s (Multi Business
Corporations) in US and UK, a value of $1 trillion can be created.

Value Destruction is the reason for Breakup – First cause for value
destruction by the corporate center. The second reason is from several frictions
that happens.

Breakup for the insiders – The chairman of the company can now become the
chairman of multiple companies. CEO’s salary in many cases is linked with the
share price and as the share price goes up, so will the salary. Senior managers
can now be more focused.

Sumantra Ghosal on MBC and FBC (Focused Business Corporation) –


Atmosphere at most MBC’s is that of downtown Calcutta in summer. “Its
oppressive. You feel drained of energy. New ideas all seem too difficult”.
Whereas the atmosphere at FBC is that of woods outside Fontainebleau in
France (INSEAD). “You feel spring is permanently in air. New ideas flow through
you like electricity. Everything seems possible, You feel recharged”
Chapter 1: The epidemic breaks out

Dollar value (in billion) of breakoff transactions in US – 1985 – 1.9, 1989 –


10.1, 1992 – 16.2, 1994 – 30, 1995 – 76.6, 1996 – 85.3.

Dollar value (in billion) of breakoff transactions in UK –1989 – 3.9, 1992 – 7,


1994 – 0, 1995 – 2.9, 1996 – 5.9.

It works!! – JP Morgan analysed the stock market performance of 77 companies


that spun-off. Average spin-off performed 25% better in the next 18 months. The
larger one’s performance went up by 13% and that of smaller by upto 45%!!13%
and that of smaller by upto 45%!!
Chapter 2: What drives Breakup?

1. Managers genuine desire for increased focus

Under-valuation arises when the company is viewed as too diversified for


the following reasons

• More overhead is needed to manage the diverse portfolio

• Highly profitable business may subsidise dogs

• Management may too much for diversifying acquisitions where


investors could buy them directly without paying a control premium

• Investors do not have the opportunity to invest directly in a business


they want to be involved in

• Diversification makes it difficult to analyse them

• Analysts coverage is often restricted to the company’s primary


business activity.

2. Management’s desire to see a “fair” share price

• Stock market prefers “pure play” than a company working on broadly


defined industries

• More analysts follow the company after breakup!

• CEO’s sometimes see “pure play” as a disadvantage as this is likely to


attract a bid. The bid might be good for the share holders, but not for
the management.

3. Finding money to reduce debt

4. Fear of takeover

• Hostile takeover threat was a primary reason for breakup in the UK.
• Many time attempt for hostile take over is the result of the
underperformance; but once spun-off, it releases lot of value and
hence will be difficult for takeover.

5. Competitive conflict

• Vertical integration can backfire. Customers of one division might face


competition from another division of the same company.

6. Poor performance

7. Pressure from regulatory and antitrust authorities

8. Quarantining a problem

9. Better tax efficiency of breakup compared to trade sale

10. Financial engineering fad

Difficulty with Focus – It is an elastic concept linked with the concept of “core
business”. Boundaries of core business are often reworded to stretch over a
portfolio.

What is Focus – Not just narrowing the scope of the portfolio. Key to focus is the
existence of a match up between the needs of the portfolio businesses and the
specific skills the center which can help to the business.
Chapter 3 – The real reasons why Breakup creates value

Value Destruction – Not the fault of poor management or poor strategy. It is


intrinsic and systemic to MBC’s. Business gets held back by the membership in
the bigger corporate entity. According to Gary Hamel and Prahlad as written in
Competing for the Future, “ the bottleneck is normally at the top of the bottle”.
The easiest, fastest and most reliable way of removing it is to break the bottle,
allowing the separate pieces to perform without constraints.

Justifying Corporate Centre – If the grouping of 10 operating businesses under


one center is to be justified on economic grounds, it must be on the basis that the
business in aggregate will do better as a group than they would as 3 or 10
independent firms. To justify one company, the corporate center must add value
to the individual operating companies.

Every business after break up will incur more administrative and financing costs,
still they perform better, because they are released from some constraints that
existed in the group.

Value Destroyers

1. Executive Influence

a. Lack of fit between the owner and owned – There is a misfit between
the center and the business it owns. Center doesn’t understand the
business and may take worst decisions.

In the mid 80’s all the oil majors like Atlantic Richfield, BP, Exxon, Shell
and Standard Oil got into the minerals business. Soon they all had an
average return on sale of -17% whereas the focused minerals
companies had +10%. This drastic difference of 27% is what pays
when a company is focused.

Oil companies are conditioned by particular experiences. Applied in


other fields, they can prove wrong. Even slight difference can be very
expensive.
b. 10 percent Vs. 100 percent paradox – How can group CEO’s in their
10% time see better ways forward than energetic managers who
devote 100% time to do their business?!?!?!

c. The truth possession and Perversion Paradox – To take better


decisions, the center must be well informed about the operating
companies. But most of the information is with the Business Managers
of individual operating companies.

d. The Alienate Syndrome – Many a time one has to go that extra mile
with the customers to get the business. A corporate center which is
never with the customer cannot do this and hence the danger of
alienation is ever present.

2. Linkage Initiatives – This is the process of encouraging interactions between


the businesses in the portfolio. Linkage initiatives start with hopes of finding
and exploiting synergy. Synergy is many times a trap.

There are cases when linkage initiatives is successful – in case of joint


purchasing or coordinated manufacturing etc.

3. Central Staffs –Good center staffs can add value, but quite often they are not.

4. Portfolio Development – Involves acquisitions, divestments, corporate


venturing initiatives etc.

Seller the gainer - Most of the value released from acquisitions goes to the
seller and not the buyer. In most cases, before buying, the buyer will have to
project his plans on the buying company. When there are multiple buyers
bidding, then the buyers will have to offer more in terms of plans. Hence they
end up not just paying premium for the buy, but also will have to invest a lot in
the plan charted out.

Corporate Ambition – When buying out, one needs to know what the
company is worthy of, what it can earn etc. Then it depends on how one runs
the company, the actions of competitors etc to know how well it actually does.
Experience shows that it can vary +/- 50% making the future very uncertain.
Research shows that the corporate center destroys at least 10% of the value of
each standalone component. Hence it can destroy even more than 50%!!
Chapter 4 – Do You need to Break Up?

1. Identify the natural clusters in the portfolio. Final clustering is based on two
facts:

a. How similar are the critical success factors and how easy is it avoid
value destruction?

b. How similar are the improvement opportunities and hence how easy
will it be to develop the skills and resources to exploit them.

2. Does the center fit with the Cluster(s)?

a. Success and failure Analysis

b. Opinion of Business Managers

3. Is there a logic for keeping the clusters together?

4. Does the multi-cluster logic stand up to challenge?

a. Will investors buy it?

b. Does the past performance support it?

c. What hard evidence can be provided?


Chapter 5 – Anatomy of Breakup

1. Pressure for Breakup

a. Breakup is always the result of some kind of a pressure. No breakup is


proactive. Reasons are

i. Conviction of insiders and investors that the stock is


undervalued

ii. Outsiders and commentators suspect company’s strategy has


failed or is inadequate

iii. Managers hear the heavy footfalls of predators and see the
shadows of suspected stalkers

iv. Pressure from powerful customers who are also corporations


competitors

v. Bankers and preferential shareholders apply squeeze arguing


debt is too high.

vi. Company needs to raise extra cash

vii. Pressure from industry regulators

2. Resistance and Acquiescence

3. Breaking Up

4. ReBirth

Tips for Successful Breakups

• Expect emotional resistance

• Sell the positive aspects if breakup

Alternatives to breakup – rationalizing the portfolio, downsizing the


corporate center, restructuring divisions – are more evolutionary, but
less attractive. They basically don’t eliminate the problem
• Treat financial costs and outcomes as one input only

• Create a breakup “Credo”

Closed door meetings always lead to untold anxiety. Communicating


intentions will facilitate decision making

• Take positive managerial control of the project

• Move as fast as you can

• Communicate, Communicate and Communicate

• Expect it to be a huge task.


Chapter 6 – Profiting from Breakup

There are 4 generic investment strategies to take advantage of breakup:

1. Speculate ahead of breakup

2. Avoid breakup candidates – Invest in those low value breakup candidates


because they are likely to be more focused. Bigger ones (MBC’s) will
probably breakup to form yet another MBC.

On the contrary, FBC’s are liable to diversify. They can get dissatisfied with
tightly focused business and can get excited with growth, new adventures etc.

3. Invest in broad portfolio of breakups – Invest in all breakups immediately after


they are announced. Then subsequently sell those which are broken up to
form another MBC.

4. Selectively invest in Particular breakups – Invest only in those which are likely
to increase the value most.
Chapter 7 – Breakup: The Future

Emergence of FBC – Focus can be on different things. For instance, Canon is


good in a number of related technologies than competitors, that they will pursue
skill-based competition in more than one line of business. Unilever is a much
better marketing company!

Warren Buffet and Jack Welch can be considered as magicians for holding on to
so many businesses simultaneously. These MBC’s are likely to breakup after
these leaders departure.

Breakup is a way of achieving greater simplicity. It is a step back from the


black hole of complexity. Where it is needed, breakup is an act of great
managerial courage and wisdom