Insights from a fund manager: Spin-offs and streamlining trend in the stock market

There are many reasons why a company would choose to spin off a line of business, but commonly it wants to divide up and streamline its operations. It often turns out that the value of the individual parts ought to be higher than the whole, and a spin-off is a way of realising the difference. This is especially true when the division being spun off has considerably better growth than the parent, and may also be in a build-up phase so showing little or no profit. In this case, the subsidiary contributes only marginally to group profits, and thus little to the valuation if the group is assessed on profit multiples. But, as an independent company, it potentially becomes an exciting growth share with a high valuation.

Another common argument for a spin-off is that the spun-off company wants its own listed share that can be used for acquisitions or for an independent valuation prior to a potential merger with a competitor. Having an independent stock exchange listing can facilitate corporate deals on attractive terms.

The focus of management and the equity market on the business can be improved by a spin-off since the spun-off company becomes publicly listed instead of being a small and anonymous part of a large entity. The business can be driven more clearly and in line with its own needs, with an optimal balance sheet, investment plans, and a focus on growth at the expense of short-term profitability, etc.

So, how have our major Nordic spin-offs performed, and have they been successful on the stock exchange? SCA spun off Essity in June 2017 and, for the first 16 months or so, Essity gave weak performance while SCA did much better in the initial 14-15 months. More recently, the situation has reversed, but this is due partly to the price of pulp and partly to market demand for cyclical shares over defensives. When the price of pulp rises and the stock market wants cyclical shares, SCA performs better – otherwise Essity performs best. Overall, it has been a success, with a total return on Essity plus SCA around 18 better than the stock market although, of the two components, SCA has done best.

Epiroc was spun off from Atlas Copco in June 2018. Epiroc has since performed better while Atlas Copco's share price is up only a couple of percent. Overall, Epiroc plus Atlas has underperformed the stock market by 4-5 percent, but this can probably be blamed on the economic slowdown in autumn 2018 rather than the Epiroc spin-off. Autoliv span off Veoneer, its active safety arm, in July 2018. Since that date, both Autoliv and Veoneer have performed poorly on the stock exchange, and together have lost 28 percent compared to the market, due partly to a weak car market, and it is Veoneer that has performed the worst. Getinge spun off its tech division, Arjo, in December 2017. Arjo has since done well on the market while Getinge underperformed during the first year after the spin-off. But this year, Getinge has risen very sharply and, overall since the split, Getinge + Arjo have done better than the market.

In the past month, MTG has spun off Nordic Entertainment, Maersk has separated Maersk Drilling, and Schibsted has distributed 35 percent of its international business, Adevinta. Maersk has performed very positively on the stock market, particularly the Maersk shares, while many investors seem to have sold the spin-off, Maersk Drilling. MTG has underperformed the stock market since its split, and this applies to both arms, although MTG has been weaker than Nordic Entertainment. Schibsted has been softer than the stock market since the spin-off. It still owns 60 percent of Adevinta, and has been given an investment company discount.

In conclusion, it is difficult to see any clear evidence of value creation from spin-offs in these cases, and it is also unclear whether the parent or the spin-off does best. However, several of the shares experienced strong price growth before the spin-off, which means it would be better to own the shares from the time the plans are announced until the actual spin-off takes place. In the long term, however, it is possible that all these new listed companies will be able to issue new shares to finance acquisitions or otherwise gain benefits from their newly acquired independence.

There may also be negative effects of spin-offs. The spun-off company risks being assigned a low valuation. Investors that own shares in the parent do so because they value the business, and may be relatively uninterested in owning the spun-off subsidiary. The spin-off may also be a small and illiquid share that fails to attract big institutional owners and is not adopted into indexes. Sometimes the spin-off can have a business that shareholders do not want to own, for whatever reason, such as being in an unfashionable sector. Maersk Drilling seems to be one such share that many Maersk shareholders do not want to retain. However, there are cases when shareholders think that the spin-off is the interesting business; many Schibsted shareholders regard spun-off Adevinta as the attractive business to own and the parent, Schibsted, has attracted a discount of around 15 percent to fair value.

A spin-off also means a loss of the synergies that can be achieved in a larger group. A diversified company lowers its risks by spreading them, which allows either cheaper financing or for the company to bear more debt. In a large group, the subsidiaries can share certain costs such as executive management, investor relations and other overheads. There may be purchasing synergies in larger groups, as well as bargaining power with customers. And cooperation within the group can generate revenue synergies, such as through the vessels of Maersk Lines favouring the company's own ports so revenue and profits can remain within the group. Some companies, such as Hexagon, are good at acquiring companies with different products and allowing them to grow and develop within the group.

It is likely that there were research synergies between Autoliv and Veoneer that will be more difficult to maintain after the spin-off. Large parts of Adevinta, which was spun off from Schibsted, are based on the Blocket concept, but Blocket itself remains within Schibsted. Could the spin-off complicate the transfer of skills between Schibsted and Adevinta? Blocket is clearly finding it difficult to fire up its real estate arm, while LeBonCoin within Adevinta is more successful. Will the spin-off make it difficult for Blocket to learn from LeBonCoin?

The conclusion is that spin-offs can reveal values, at least in the short term. They provide the spun-off company with a listed share that can be used as currency for acquisitions and facilitate corporate transactions. The spun-off company gains more limelight than when it was hidden within a larger group. However, there is also a risk of negative synergies in the form of additional costs or complicated collaborations. Spin-offs are fashionable right now, but they are not always the right solution.

What spin-offs could we imagine in future? Electrolux will spin off its professional products. Sandvik will probably spin off its steel division. Maersk wants to get rid of its Supply Vessels business, as well as its freight forwarding business, Damco. Orkla does not feel like the right long-term owner of 43 percent of the Jotun paint business, or hydro power. It seems we are likely to see more Nordic spin-offs in the coming years.