A Missed Opportunity for Middle East Companies Looking to Create Superior Value

According to The Boston Consulting Group (BCG), a total of 459 divestitures were made in the region between 2010 and 2015, only four of which were actual spin-offs; globally, however, 28 spin-offs were created in 2015 alone

Globally, one of the big trends in the increasingly active market for corporate transactions has been the growing popularity of one particular type of transaction: the spin-off. Unlike selling a business to another company for cash or stock, or floating all or part of a business on the public-equity markets, a spin-off distributes shares in the new company directly to the initiating company’s shareholders. And, like any divestiture, it allows a company to increase its focus on the core, reduce management distraction, and improve the margin, growth profile, and valuation multiple of its remaining lines of business. 

According to a new study by The Boston Consulting Group (BCG) – titled Creating Superior Value Through Spin-Offs – in 2015, companies around the world closed 28 major deals worth a total valuation of $133 billion. In the Middle East, however, the number of spin-offs created is considerably low: out of the 459 divestitures made in the region between 2010-2015, only four were spin-offs: two were located in the UAE, one in Qatar, and one in Kuwait. These spin-off deals spanned several industries including Energy, Industrial, Materials, and Retail.

In parallel, for 106 of the 459 divestitures made in the Middle East, the parent company was a diversified holding company engaged in business activities across multiple industries; only 35 had a private equity (PE) fund as a parent company.

As for the four spin-offs, their respective parent companies were not diversified holding companies but entities focused on a single line of business.

“These figures demonstrate that, in the Middle East, the overwhelming majority of divestitures are created through share sales; corporate spin-offs, on the other hand, are not a common way to create value, especially within diversified holding companies in the region,” said Ihab Khalil, Partner and Managing Director at BCG Middle East. “This strongly indicates what appears to be a missed opportunity for some parent companies. After all, the value created through a pure equity sale could have actually been much higher through a spin-off.”

REAPING THE ADDED VALUE OF SPIN-OFFS

Today, for Middle East companies, spin-offs have a critical strategic advantage. They provide an opportunity to define – typically, for the very first time – a compelling investment thesis for the business in question and to set the new company up for success as an independent entity. And when the spin-off represents a substantial portion of the initiating company’s assets, it also offers an opportunity to refocus the investment thesis and value creation strategy of the businesses that remain behind. This is especially the case in so-called splits or separations.

“These strategic advantages may explain why, globally, investors seem to prefer spin-offs to other types of divestitures,” added Khalil. “In an analysis of 8,000 divestitures worldwide between 1990 and 2013, BCG found that from three days before the deal was announced to three days after, the companies doing spin-offs had nearly double the average cumulative abnormal return (CAR) of the companies doing trade sales or IPOs. This matters since CAR, a commonly accepted measure of how capital markets respond to a deal, is a good proxy for long-term value creation.”

Not all spin-offs create superior value over the longer term, however. BCG recently analyzed 80 spin-offs that took place in the U.S. market from 2000 through 2014. The firm found that the median company initiating a spin-off outperformed the S&P 500 by seven percentage points of total shareholder return (TSR) in the six months after the announcement of the move. 

The value creation at the median new company generated by the spin-off, however, trailed the market slightly in the six months after the close, and there was a broad spread of at least 38 percentage points between top- quartile and bottom-quartile performance.

What explains this wide gap? “A spin-off is a complex transaction – the equivalent of a reverse post-merger integration (PMI),” stated Khalil. “There are myriad challenges, many moving parts, and numerous situations in which things can go wrong. Creating a smaller company alone comes with its fair share of structural challenges.”

THE WAY FORWARD

BCG recommends four critical steps designed to ensure that a spin-off ends up in the top quartile. These can also serve as guidelines that Middle East companies can follow to make sure that their corporate spin-off delivers the kind of value investors expect – both at the newly independent business and the initiating company.

Here they are:

• Plan for the long term – not just for the launch. Don’t just plan for day one of the spin-off. Plan for day two and beyond – by clearly defining the long-term value-creation strategy that will enable the spun-off entity to deliver strong and sustainable TSR.

• Define the target operating model. Understand – in advance – how the spun-off company will operate and deliver value as a stand-alone company, and, when possible, take the time to set it up for success before executing the spin-off.

• Focus on the critical path. In any spin-off, there is usually a limited set of critical-path issues that, if not resolved before day one, risk delaying the launch of the new company and damaging credibility with investors as a result. Focus the lion’s share of managerial time and attention on these issues.

• Manage the hard side and the soft side of change. Change management is a critical part of any spin-off – both the “hard side” of formal governance and the “soft side” of building a new culture for a new company. Stay on top of this change process by establishing a strong transaction-management office to lead the effort.

None of these tasks is easy, but getting them right will likely be the difference between a spin-off that creates superior value and one that does not.