In many instances, spinning off a business goes against company executives’ rational self-interest of running a larger company and getting paid more. Despite this fact, year-in and year-out companies execute spin-off transactions. There are a handful of key drivers that could push a company to spin-off assets: Management, Activist Investors, or Regulatory.
As we have said before, but can’t stress enough, spin-offs go against executives’ self-interests. It is evident that company executives who run larger businesses get paid more. Therefore, why would management execute this type of transaction? After all, if a subsidiary didn’t fit with the parent company’s corporate strategy any longer, they could always sell the business to a financial or strategic buyer and retain the proceeds.
The simplest explanation is that legacy management is interested in creating shareholder value. This could be due to a number of reasons including an owner-operator at the helm or someone who was trained with this type of mentality leading the company. Either way, these situations are always of interest.
In other cases, new management comes in and views the company with a fresh set of eyes. They don’t have legacy preconceived notions or relationships that could inhibit someone else from making the right decisions for the long-term health of the business.
Activist investors can be a key catalyst for driving companies to execute spin-offs. There are two broad playbooks used by funds when going down this path.
Appealing to the Public
Activist investors periodically write open letters to the board of directors and in some instances issue a detailed presentation making the case for the spin-off or strategic review. Furthermore, they could solicit for board seats at the company to push their agenda. This puts pressure on the company to address why the businesses belong together and why a spin-off does not make strategic sense.
Behind the Scenes
Activist investors who have a stellar reputation working with companies can sway management and boards without the need to appeal to the public.
Regulatory considerations can have a meaningful impact on spin-off decisions. For instance, a company may need to spin-off assets in order to execute a large merger. In other cases, a rapidly growing company with a large market share in an industry may need to spin-off a business in order to comply with regulatory pressures.
In other situations, companies in highly regulated industries where there are different regulations based on company sizes may want to spin-off assets to stay within regulatory benchmarks. For example, banks are subject to different levels of regulation based on the amount of assets held. Thus, they may decide to reposition the business as they approach various regulatory thresholds.