The rationale for spin-offs

Article #503 by Edward Rizzo - Published Weekly

A spin-off is a corporate action whereby a parent company hives off a subsidiary into a separate business via the payment of a dividend in kind to all shareholders of the parent company who receive an equivalent shareholding in the subsidiary. The company that is spun-off generally obtains a stock exchange listing allowing all shareholders to have tradeable shares in both companies.

There are various reasons for conducting a spin-off such as the need to have independent management and strategies for each of the different business units. More importantly, most spin-offs take place in order to unlock shareholder value. The general belief is that the market usually values a diversified group of companies at less than the sum of its individual business units. This is commonly referred to as the ‘conglomerate discount’ and it reflects the challenges and inefficiencies that arise in managing a diversified group of companies as opposed to specialising and focusing on one business strategy. As such, conducting a spin-off of one or more business units may be considered as an attractive strategy for certain directors or senior management executives.

Spin-offs are a very common occurrence across international financial markets. To mention just a few examples, in 2015, following pressure from the renowned activist investor Carl Icahn, the online auction site eBay spun-off PayPal, the digital payments company that it had acquired more than a decade earlier.

In recent days, there was a lot of coverage across the international media about possible spin-offs across the European auto industry. The German company Daimler AG recently made reference to a review of the company’s structure in a conference call with financial analysts and as a result there has since been widespread speculation that the German car manufacturer is considering a separate listing of its ‘trucks and bus’ division as the company moves towards the creation of three separate legal entities. Some financial analysts have already opined that this would create significant shareholder value.

Meanwhile, although Volkswagen seems to be preparing to dispose of its entire stake in the Italian motorcycle manufacturer Ducati via a trade sale and not via a spin-off, many industry observers claimed that this could start off the process by which the German carmaker may begin to unlock value for its shareholders following the diesel scandal which had a significant impact on the company’s valuation. Some analysts believe that VW may eventually contemplate spinning off Porsche following the very positive experience for Fiat Chrysler when it spun-off Ferrari in 2016.

Fiat Chrysler had conducted an Initial Public Offering in late 2015 and sold a 10% stake in Ferrari to retail and institutional investors. It had maintained an 80% shareholding as the remaining 10% was held by Ferrari’s Vice Chairman, Mr Piero Ferrari. Afterwards, Fiat Chrysler distributed its 80% stake in Ferrari to its shareholders at the start of 2016. Since the spin-off exercise, the share price of Ferrari increased by circa 140% as the Italian sports car manufacturer was attributed a valuation multiple in line with luxury goods manufacturers rather than a multiple similar to other auto companies. Ferrari now has a market capitalization of USD20 billion which exceeds the market capitalisation of Fiat Chrysler of USD18 billion. Meanwhile, a few weeks ago it was reported that following this positive corporate action, Fiat Chrysler is now also considering spinning off some of its other brands, namely Maserati and Alfa Romeo, as the company seeks to streamline its business ahead of a possible merger with other car companies.

Another advantage of a spin-off is that it gives investors added flexibility in managing their investment portfolios. Following a spin-off, shareholders can then decide for themselves, in line with their investment objectives, whether to hold, sell or add-on to their direct shareholding in the newly publicly traded company.

For example, a subsidiary requiring further equity injections and additional debt funding for capital expenditure may not be in a position to distribute dividends to shareholders for several years. In that case, dividend seeking investors who would have received shares in the subsidiary would then be free to decide whether to dispose of the shares in view of their income strategy. Shareholders would not be able to avail themselves of this opportunity if the subsidiary is retained by the parent company.

So far in Malta, only one spin-off exercise was conducted when in October 2015, all shareholders of GO plc received a dividend in kind of €0.331 per share and were given shares in the property subsidiary Malta Properties Company plc. It is interesting that this spin-off took place as the previous majority shareholder of GO plc, Emirates International Telecommunications Malta Limited, was contemplating a divestment of their telecom assets. However, in view of their continued interest in real estate, a decision was taken to spin-off the property portfolio wherein Emirates International maintained their 60% shareholding of this subsidiary while offers were sought for the telecom business. Trading in the shares of Malta Properties Company plc commenced in November 2015 and immediately rallied to well above €0.70 during the first few days of trading. The share price of Malta Properties has since settled at just above the €0.50 level which again represents a premium to the dividend in kind of €0.331.

Another spin-off is expected to take place in Malta in the coming months. In June, I had explained that ahead of the 2017 Annual General Meeting that took place on 27 June, all shareholders of Simonds Farsons Cisk plc received an explanatory circular explaining the special resolutions that were put forward for approval ahead of the spin-off of the company’s shareholding in Trident Estates Limited. Similar to the examples that have taken place overseas as well as the spin-off of Malta Properties Company plc, this corporate action will also be carried out through the payment of a dividend in kind by way of a distribution of the company’s shareholding in Trident on a pro-rata basis to its shareholders.

There is still no specific date as yet when the spin-off will take place and when Trident Estates will be admitted to the Regulated Main Market (or Official List) of the Malta Stock Exchange (MSE).

Prior to the actual listing, an announcement also needs to take place to confirm the record date for the distribution of Trident shares from Farsons to each of the respective shareholders. This will determine which shareholders are entitled to receive the dividend in kind. The share price of Farsons has continued to increase rapidly in recent months and this week it touched yet another record level of €8.55 possibly as new investors seek to gain exposure to Farsons ahead of the actual spin-off.

The record date is also important in view of the necessary adjustment in the share price of Farsons once the shares turn ex-dividend. In June, I had explained that the expected special dividend to be received by Farsons shareholders entitled to the Trident share is of circa €1.19 per share which may need to be amended dependent on the latest valuation reports being prepared. Trident Estates will be issuing a Prospectus prior to the listing of its shares which will show the exact dividend to be received. Once this is determined, it will also establish the adjustment that should take place in the share price of Farsons to reflect the assets being transferred out of the group into Trident Estates. The Prospectus should also explain the property strategy of Trident which would require a rights issue in 2019 to partly fund the first development.

Directors and senior executives of Maltese public companies should become more proactive and follow international trends to ensure that shareholder returns are optimised. In recent weeks, I mentioned other important topics across financial markets, namely share buybacks, distributing excess cash to shareholders or obtaining the right level of leverage to distribute higher dividends and enhancing returns on equity. Some Maltese companies should also contemplate a spin-off strategy similar to GO plc and Simonds Farsons Cisk plc. There are a few evident examples of some companies that may benefit from such a strategy.

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