LAST week, one major Dow Jones Industrial Average constituent and another former big name of the 30-stock index announced plans to split their companies in a move to create value for their respective business units.
General Electric (GE) was the first to announce a split of the company into three separate public companies, focusing on energy, healthcare, and aviation, which will put to end the history of the 129-year-old conglomerate that was once the most valuable company in the United States.
GE’s move was quickly followed up by healthcare conglomerate, Johnson & Johnson (J&J), which announced plans to split its consumer products business from its pharmaceutical and medical device operations, creating two publicly traded companies.
Both the GE and J&J announcements were met with resounding applause from the market as their share prices closed 2.6% and 1.2% higher post announcements.
There are reasons why corporates embark on business spin-offs, but typically it is for the relatively large profit-oriented unit to have greater autonomy in terms of capital allocation and funding, a greater focus on that particular business area, and strategic flexibility to drive long-term growth via organic growth or merger and acquisitions, which undoubtedly is meant to create value for all stakeholders.
Johnson Johnson
In addition, as far as valuation by the market is concerned, a company with multiple business divisions will be attached a holding company discount as analyst typically assigns this discount when valuing a conglomerate. Hence in its original form, there is a great tendency for the sum of parts of a conglomerate to be more than the value assigned to the holding company itself.
On the other side of the coin, some investors do not prefer a large conglomerate to be spun-off as this will result in the newly created entity or companies being on their own without the experience of strong board leadership.
There is also a possibility that the value attached to the stand-alone business may be well below that of the holding company before, and last but not least, in certain cases, a particular business division may end up with a higher gearing level mainly due to the nature of the business itself. This could likely be the case in capital-intensive businesses such as oil and gas or telecommunication or even the utility sector.
The Malaysian experience
Malaysia’s best-known example for a corporate spin-off was when Sime Darby was split with two new separate listed entities four years ago. Sime Darby Plantations (Sime Plant) and Sime Darby Property (Sime Prop) were spun-off from the original Sime Darby (Sime).
Sime Darby building
Shareholders of the holding company were allocated equal shares in Sime Plant and Sime Prop for every Sime share held and with a reference price of RM5.59 and RM1.50 respectively, while Sime itself was attached a reference price of RM1.85 per share. Collectively, the original Sime, with a last traded price of RM8.94, was split into three different corporates with individual reference prices, which in total was equal to the original Sime share price before the spin-off took effect.
Based on today’s market prices, Sime’s market price is RM2.21 (up 36 sen or 19.5%); Sime Plant is at RM3.96 (down RM1.63 or 29.2%) and Sime Prop is at 67.5 sen (or down 82.5 sen or 55%).
Collectively, the three companies have a combined value of about RM6.85, which is about RM2.10 or 23.4% lower than the pre-split value of RM8.94 per share. At RM6.85, the combined value of the three companies in terms of the share price is back to the level where Sime Darby as the original holding company used to trade in June 2009!
Potential spin-offs in other listed companies
Among the large corporates, we have also seen a spin-off involving IOI Properties by IOI Corporation, IGB Commercial REIT by IGB, Axiata by Telekom Malaysia, among others.
When measured against the share prices of the spun-off units and their respective original form, the results are relatively mixed. It all depends on the investors’ sentiment on a particular sector as well as a specific issue related to the spun-off unit itself.
What are the other potential spin-offs that we can expect from corporate Malaysia? There are two to three potential ones at this stage and this includes Affin Holdings’ plans to take divest Affin Hwang Asset Management and Malayan Banking Bhd’s plans to sell its insurance arm, Etiqa, as well as Tenaga Nasional, which may see the spin-off of its power generation business, while transmission and distribution activities will remain under the currently listed entity.
Can spin-offs create value for shareholders?
The issue with the spun-off companies is very much sector-specific. For example, certain sectors may be out of favour for now and this includes the property sector, which is up against a weak market sentiment especially at the high-end and high rise segment, as well as the severe overhang that is being felt across the property market segment, except for the industrial segment.
In the plantation sector, despite record-high CPO prices, issues related to environment, social, and governance and deforestation have taken precedence instead. On the other hand, certain sectors may be the flavour of the season, especially for companies with business units where the market is willing to pay a high premium.
For now, that is seen in the technology sector, certain consumer segments (for example in the space where MR DIY and CTOS Digital is occupying), or even startups. As we have seen valuation on certain startups has just gone to the moon and hence for companies that are incubating these companies, to spin them off in the market makes sense as investors will be willing to pay a premium. Going back to GE and J&J, the question would always be whether the company in its original form has a better value than the spin-off businesses and whether will shareholders will be better off or otherwise. Only time will tell as we have seen in the case of Sime.
Pankaj C Kumar is a long-time investment analyst. The views expressed here are his own.