Sell or spin? The strategic alternative to M&A
Spin-offs can present an attractive alternative to M&A for companies considering strategic divestments and given the challenges to dealmaking in the current environment – illiquid capital markets presenting financing issues, counterparties struggling to agree pricing assumptions in an uncertain macro environment and regulatory hurdles to deal execution continuing to grow – we expect this to continue into 2023.
This is particularly the case in sectors such as industrials and pharmaceuticals, which are dominated by conglomerates that have grown inorganically through acquisitions and in which these separate businesses have retained some degree of independence and separation from the wider group.
Spin-off transactions can be structured in different ways but ultimately involve the distribution by a listed company of shares in its subsidiary (the SpinCo) to its shareholders, thereby establishing two separately owned and managed companies. They are attractive to companies if there is a belief that the trading value of the group is less than the sum of its parts and this value can be realised if otherwise distinct divisions or businesses are able to trade separately. Often, the SpinCo will benefit from refreshed management focus, or may be freed from costs or regulatory constraints associated with the remaining group that previously weighed on its valuation. The spin may also attract new investors with a more specialised focus. It is also frequently the case that the tax base for the SpinCo assets held by the parent company is low because they have been held for a significant period of time. This again leads to pressure on achieving a satisfactory valuation multiple in a M&A transaction to justify the tax on the capital gain, which is difficult in the current environment. Conversely, a spin-off will usually be structured to be tax-neutral for the parent, and the market can be left to its own devices to determine the appropriate valuation over time.
It is worth bearing in mind, however, the potential pitfalls in achieving a spin-off. An obvious factor that will need to be considered is the potential for dis synergies to be created by duplicating public company and back-office functions and overheads, and whether these may outweigh the perceived benefits of other cost savings. Companies should also expect an increase in share price volatility in the short-term following the spin-off as the market adjusts to repricing the separate investment proposition presented by each company, and as investors take the opportunity to adjust portfolios. Company boards may be reluctant to proceed with a spin when equity capital markets are uncertain, with the potential embarrassment factor to consider of a post spin drop in share price, that may leave investors unhappy that a third-party sale was not pursued. Also, the effect on the inclusion of the parent company and SpinCo in relevant share indices needs to be considered.
While a board may have greater confidence that a spin will complete compared to a third-party sale which is conditional upon antitrust or other regulatory approval, our experience advising multinational conglomerates on complex spin-off transactions shows that a pre-spin reorganisation may still trigger foreign investment filings in many jurisdictions around the world. Depending on the nature of the transaction, it may be reasonable to expect these to principally be technical filings rather than substantive approval processes, but the cost and resource impact should not be overlooked. Additionally, issuers will need to consider the jurisdictions in which its shareholders are based to determine whether the spin-off requires a prospectus or other disclosure documentation to be prepared under overseas securities laws, or a waiver to be sought from applicable securities regulators. The impact of such regulatory processes can be significant and should be planned for well in advance.
Preparation is key
The extent to which the SpinCo is integrated within the parent company will determine the level of post-closing transitional support that is required – if separating the businesses will require the parent to commit to an expensive long-term transitional support arrangement for the SpinCo, the spin-off might seem less appealing than a sale to a strategic acquiror that may be more able to support SpinCo with its existing infrastructure from day one. The complexity of setting up both short- and long-term transitional arrangements, putting intra-group arrangements onto arm’s length terms in a tax efficient manner, or creating the distributable reserves needed at the parent company level to spin the assets to shareholders are just some of the factors that contribute to the typically long lead times (as well as costs and management time) required to achieve a spin-off. All this needs to be appropriately weighed against a sale which may be simpler in certain respects and through which the company will receive at least some proceeds.
Whether or not a spin-off transaction is the best course of action for a company looking to dispose of a business unit will depend on a multitude of factors, but as we look ahead into 2023, we expect it will remain a meaningful alternative to M&A for a wide range of companies.
Arun Balasubramanian パートナー
Hong Kong, Singapore
Dr. Heiner Braun パートナー
Frankfurt am Main
Kate Cooper パートナー
Sebastian L. Fain パートナー