SPIN-OFFS have long been popular in US TV circles. Take an integral element in a successful concept, separate it, set it on its own two feet and watch it flourish. For UK plc, spinning business units off for sale is also becoming fashionable.
Spin-offs were previously the preserve of academic and high-tech organisations looking to commercialise an innovation. But now, from the largest corporates (think banks and other financial service giants) to the lower end of the mid market, spin-offs are now serving an important purpose for a range of businesses.
So what do they involve, and why are they becoming more common?
The basic economics are clear: many diversified businesses in the UK have suffered in the recession and need to do something about it; as a corollary to that, there are a growing number of potential buyers for spun-off assets.
“There are several reasons why people are looking at non-core disposals, or spin-offs,” says Jonathan Boyes, who heads up KPMG’s corporate finance team in the north of England. “One is defensive – they are intended to raise cash where businesses have ended up overgeared or are having difficulty refinancing or are looking to reduce their net debt, so they look to sell off subsidiaries to stabilise their businesses.”
Then there are those companies that take a dispassionate view of what is core and non-core. Whether that is BP or Shell deciding to shed non-core service businesses, or a mid-market company getting rid of a loss-making unit, they’re all trying to identify assets that neither logically or financially make sense to own. That can be explained in part by the number of companies that bought assets at inflated prices – often financed with debt – pre-2008. The disposal of those assets now forms a central plank of their FD’s agenda.
The first type of spin-off can be described most accurately as defensive – they take risk and debt off the balance sheet, and offer an attractive way of refinancing the business in lieu of help from the bank by using the cash generated to better leverage or revitalise their core competencies. The second type is more strategic and comes about when a business wants to refocus time and resources on its core assets and remove the distraction of non-core assets.
Phil Dunmore of PIPC, a project management consultancy that handles de-mergers and post-sale for corporates, says spin-offs also make sense when a business takes a hard look at itself and decides what it wants to be.
“If you look at the likes of the oil companies, they are becoming clearer on whether they want to be present at every step along the value chain or whether they want to focus on key elements of that,” he says. “Shell has been doing that a lot across the world; BP too.”
Some deals combine both elements. For instance, the sale by agricultural production business NWF of its garden centre business in 2009 fits that bill. As a distribution business, it had made a certain amount of sense for NWF to own a garden centre business. But as the recession deepened, it was clear that running a retail business at a remove to its core operations made little sense, given the garden centres’ poor financial performance. As a result, it sold the garden centre business that was making a loss for £14.5m.
“NWF achieved an effect of both de-gearing through the reduction of the debt, and made the business more profitable since it got rid of the loss-making unit,” says Boyes. “It was a classic case of a business that had pursued diversification and then looked at a non-core asset and got rid of it.”
However, simply identifying the asset for sale is just the beginning. Once that is done, then it becomes a question of valuation and execution.
Valuation, in particular, is something Boyes admits is not always easy; not least because what is being sold will instantly become a new, different business once the deal is completed.
“It’s important to understand that what the business looks like as a standalone entity could be more profitable and valuable on its own than as part of a group,” he explains. “We often see business managers, once they’re released from group control, going on to become very creative and innovative when it comes to ideas and ways to increase profitability.”
As a result of this liberation, those businesses can grow in value markedly following sale to a private house, for example. “As FD you need to understand if the business is worth more to the buyer standing alone, particularly if the buyer is going to extract cost synergies,” says Boyes.
“If it’s a trade buyer, they may be able to reduce duplication through consolidation, so the value may be considerably higher than the earning stream that’s being sold by the seller. If those synergies are identified, they can be reflected in a higher price.”
Those prices are also more attractive to a new kind of buyer: overseas players. Companies from high-growth developing economies – China, India, the US – are increasingly snapping up UK spin-offs.
“Sterling has depreciated substantially in the last few years and the UK has been moving out of recession slightly behind a number of others in the world, so they’re thinking now is a good time to look into acquiring in the UK,” says Boyes. “So in a number of sectors, that’s one of the key drivers: overseas trade buyers taking advantage of the currency issue who also have strong financing positions.”
Once a valuation has been arrived at, then the process of extracting the asset from the parent can begin. And that’s where Dunmore comes in, helping businesses separate and remove the asset with the minimum of angst.
“One of the key challenges there is the issue of selling a fully functioning, well integrated and operationally efficient unit, so when you try to divest yourselves of that, you’ve got to undo all the ties that bind and that can be complex, whether that be technology, operational issues or personnel,” says Dunmore.
“And you tend to find that rather than wholly divesting the asset in one step, businesses are finding themselves going through a transition period where the asset for sale is ‘half sold’ and the selling organisation still provides a number of services so that asset is able to remain viable and functioning,” he adds.
At the same time, the buying organisation is charged with establishing the infrastructure and systems to keep the unit going. Typically, organisations do not usually have that capability in house.
“Therefore, the risk from the FD’s perspective is planning those things from the point of view of structuring the deal correctly to ensure they’re prepared to managed that transition,” says Dunmore.
How that process is managed will largely depend on who is buying the asset. Trade sales are usually the most seamless way of spinning off an asset: the acquiring company will likely have complementary systems in place to accommodate the new asset, with the experience to incorporate most of its functions.
However, private equity (PE) buyers – the sector that in many ways underpins the spin-off market – present a different challenge. Typically, PE investors will want to buy a business off the shelf with minimal need to rebuild or provide new infrastructure. In that instance, an MBO is often the favoured route.
At the top end of the market, however, a third possible exit route is gaining in popularity: the IPO. Lloyds Banking Group, among its many pressing concerns, has the little matter of 630 branches to dispose of. The market for such assets can be euphemistically described as depressed, while regulatory concerns make a trade sale unlikely. With few options left, Lloyds has said it may spin off the branches into a new, listed entity. Under that arrangement, it might also be possible for Lloyds to retain a stake in the new business.
That route will only be open to larger businesses, but with the number of eager buyers increasing, and private equity houses still sitting on cash piles ready to invest, it is likely the market for spin-offs will remain healthy for a while. ?
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