Conglomerates are Breaking Up
by Jeremy Baksht - Azafran Director of Investments
The closest thing to a buy one, get one free deal on Wall Street is a stock Spin-off. Spin-offs are a relatively well-known form of corporate restructuring that has ramped up in recent years as a result of increased shareholder activism and growth expectations to match cycle high valuations. Spin-offs are essentially when a subsidiary business is separated from its parent company via the creation of a new and independent entity. Typically, the shares of the subsidiary are distributed tax-free to existing shareholders of the parent company or sold to the public in an IPO “carveout”. Investors like spin-offs because they often prefer focused companies to diversified ones.
Companies also pursue spin-offs to create a business-appropriate right-sized capital structure with an optimal debt-to-equity ratio that matches the growth and risk profile of the business and to enhance the effectiveness of equity-based compensation. A spin-off will create distinct and targeted investment opportunities in each business. A more “pure-play” company may be considered more transparent and attractive to investors focused on a particular sector or growth strategy, thereby burning-off the “conglomerate discount” and enhancing the value of the business. Further for M&A purposes the stock of the acquirer will often be a better fit for offering value to an acquisition target in an appropriate cash-stock mix of a comparable business.
GE recently announced it will divide into three businesses, with GE Healthcare becoming a separate company in early 2023. GE Healthcare is a $17 billion business that encompasses diagnostics, interventional imaging, life care and therapy planning. Zimmer Biomet also announced in February that the company is spinning off its dental and spine units into an independent company.
“As separate entities, each of the GE spin-offs will have more strategic focus and financial flexibility to pursue growth opportunities and can allocate capital according to industry-specific dynamics. The flexibility will allow the new companies to invest more in existing and adjacent growth markets with new or complementary technology and capabilities. In healthcare, this might mean going further upstream into interventional and therapeutic modalities, while integrating around a patient disease state to drive better outcomes and increased productivity.” said Lawrence Culp Jr., CEO of GE who also pointed analysts to GE’s recently announced plan to buy surgical visualization specialist BK Medical for $1.45 billion as a step toward that aim.
Further, Culp described the future of healthcare as focused on integrated, efficient and highly personalized care that requires merging clinical medicine and data science by applying advanced analytics and artificial intelligence across every point of the patient’s journey. “GE is one of the few companies with the reach, capabilities and relationships to do this.” said Culp.
“Within the medtech sector, we have noticed robust M&A activities, which GE Healthcare has virtually not been a part of to date. Now as a standalone business, GE Healthcare can accelerate decision making, focus on key growth areas and more effectively leverage the scale of the portfolio to participate in future M&A transactions.” said Nathan Ray, a partner in the healthcare and life sciences practice at consultancy West Monroe.
Several other marquee conglomerates announced Spin-offs so far this year including J&J, Toshiba, Zimmer Biomet, GlaxoSmithKline, Becton Dickinson, Colfax, Tenet Healthcare, AIG, and Sanofi. These announcements often highlight that strategic reorganization is the right step for sustainable profitable growth of each business and the best path to create additional value for our stakeholders. Value is unlocked by removing complexity, and enabling the businesses to have much more focused management, agile decision making, and offer shareholders the choice to sell or hold the businesses.
J&J announced that the company is splitting in two, with the pharma and device units remaining under the J&J brand and the consumer health brands becoming an independent company. J&J expects the move to take place within 24 months, and costs are projected at a range of $500 million to $1 billion. Moody’s analysts wrote that while J&J’s size and diversity of products has boosted its rating in the past, the “consumer products business is becoming less synergistic with J&J as a whole due to fewer opportunities to apply scientific innovation and changing consumer preferences.”
Spin-offs generally prove to be good for all stakeholders and keep conglomerates from being too unwieldy to manage appropriately. In particular the R&D and inorganic growth opportunities led by a more focused management team and equity structure allow for doubling down on market trends and utilizing stock for attracting innovative growth companies for acquisition.