breaking companies apart: the cons

Many times, separating a conglomerate into its component parts creates value.  Sometimes, it can produce enormous gains.  Spinoffs of corporate stepchildren are often particularly lucrative.  Take Coach (COH) for instance.  Its stock rose by 40x in the first five   years after it was spun off, unloved and starved for expansion capital, from Sara Lee.

There are other instances, however, where breakup can be disastrous.  This may not be evident at first in the stock price action of the separate components, but the ultimate bad news can happen in a number of ways:

1.  Onerous corporate liabilities–debt, lawsuit liabilities, incompetent executives…may all be shunted into one of the new parts, which is more or less designed to fail.  No one will say this, of course.

The first place to look for this kind of imbalance is in the part where the CEO and other top executives aren’t going.  Often, executives in the disfavored part of the split will be so excited to finally be the top dog that they’re delusional about their ability to deal with the negatives they’re being loaded down with.  After all, Davy Crockett might have survived the Alamo if he’d been a step quicker;  the Donner party might have gotten through those mountains…

2.  Sometimes a proposed split will end up forcing apart two businesses which need each other to be successful.  In the current hedge fund era, when individuals with little operating experience can wield large amounts of financial capital, this is a particular danger.  Activists. for example, have wanted Target (TGT) to sell/divest its credit card operations a couple of years ago.  Yes, TGT would receive a large one-time payment, and its stock would probably go up.  But its credit-related operating costs would rise.  And the company would have lost the considerable “Big Data” advantage that it gets from being able to see all the credit transactions of its cardholders–not merely transactions done at Target stores.

I think the current talk of splitting up Microsoft (MSFT) is well worth monitoring in this regard.  Sure, spin off  the consumer device business.  To my mind, though, splitting Windows, Office and the cloud from one another is just asking for trouble.

3.  Another issue that has emerged in recent years–the activists may be bunglers.  Look at J C Penney (JCP).  Activists correctly saw that JCP was crediting profits it got from its control of valuable real estate to its retailing operations.  That covered up the true weakness of the company’s retail offering.  But their attempt to “fix” retailing before breaking up the company went horribly awry.  Worse, they persisted in their mistaken direction so long that they created a downward spiral the company has yet to pull out of.  The stock, which some speculated could be worth $50 a share, has dropped from around $30 to $5 or so as a result of their “stewardship.”

3 responses

  1. This post really hits the nail on the head – many times inexperienced operators with huge hoards of cash (you reference hedge funds, add to that easy money from basically free money provided by the FED to just about everyone doing LBO) over look some basic dependencies within operating businesses.

    I disagree on Microsoft though. I believe splitting Microsoft’s Windows, Office, and Server businesses would provide impetus for innovation, just like breaking up AT&T did last century.

    JCP, what a disaster.

    • Thanks for your comment. I’m sure you know MSFT better than I do. I agree that a breakup of MSFT’s main divisions would be an ATT-like event that spurs innovation–in other words, a good thing for the economy. My reservations are on the narrow question of whether this would make the holders of the pieces of MSFT wealthier. I can imagine events playing out either way.

      • I believe that a breakup of MSFT would make the shareholders much wealthier. Imagine a Windows Server only company, unfettered to focus solely on enterprise level functionality, and more importantly, joint ventures. Oracle and SAP would be much more willing to play I think.

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