‘Bigger is better,’ was what IROs of conglomerates used to say, before they discovered the joys of demerging. Today, demergers are all the rage, as fashionable as black evening wear or showing up late. Several high-profile companies, from Thorn EMI in the UK to Chargeurs in France and AT&T in the US, have recently demerged as a way to gain management focus, attract analyst coverage and win higher multiples for growth businesses buried within a corporation.
As the term implies, ‘demerging’ is a repudiation of the whole merger mindset, where size equals market clout. But convincing loyal shareholders that large companies will be better off if unrelated businesses go it alone can be an awkward role for an IRO to play. Fortunately, most investors don’t balk for too long at a sudden about-face, especially if the overall strategy makes sense.
For instance, this April, when London-based Cordiant announced its intention to demerge, the news was welcomed, even though it represented a dramatic change of course for a company that had only married its two major advertising firms, Saatchi & Saatchi and Bates, two years ago.
Pure Plays Preferred
‘The demerger of a conglomerate or a company with diverse parts is generally an easy sell to investors,’ according to Mike Useem, professor of management at the Wharton School, University of Pennsylvania. Individual investors, he says, prefer pure plays, or companies in focused, easy-to-understand business lines. And most analysts and money managers view demergers – referred to in investor parlance as strategic restructurings or spin-offs – as a smart strategy for unlocking shareholder value.
Though the case for demergers or spin-offs sounds impressive, some cynics insist they are a temporary fad, the latest wrinkle dreamt up by investment bankers and consultants eager to keep fees rolling in. Others say today’s enthusiasm for demergers is nothing more than the pendulum swinging away from conglomerates. ‘Conglomerates are out of fashion,’ contends Eric Buck, VP and telecommunications equipment analyst for Donaldson Lufkin & Jenrette. ‘People have not been bidding up to high valuations the conglomerate approach.’ In other words, demergers look attractive by default.
Jeff Zilka, senior managing director of IR agency Hill & Knowlton in Chicago, maintains that while markets do tend to be faddish, there are sound reasons why streamlined companies and pure plays are now in vogue. The stock market, he says, is relatively buoyant, investors are feeling confident about picking winners, and managers are itching to exert greater control over performance. ‘In the current environment,’ observes Zilka, ‘it’s no wonder that spin-offs are the cat’s meow.’
Selling Investors on Demergers
As the first and only French demerger, Chargeurs had to be particularly clear about why it was dividing into two separate, publicly-traded companies: Chargeurs International, a textile company, and Pathe, a television and media venture.
Jean-Pierre Valais, who now heads IR for Paris-based Pathe, describes the former Chargeurs as ‘a curious animal,’ lacking synergies between its businesses. ‘It was very difficult to understand the strategy of the company,’ says Valais. ‘The share value was discounted because of that.’
The decision to demerge was spurred by institutional shareholders and analysts pressing management to find a way to clarify the relationship between the businesses. At the time it was viewed as an extremely bold move by Jerome Seydoux, president directeur general of Chargeurs.
‘When we said that we had decided to demerge, it was a great surprise. In France, no company had ever demerged, so it wasn’t considered possible for fiscal or tax reasons,’ says Valais. The restructuring demonstrated that, under existing laws, a French company could break up without getting hit with a big capital gains bill.
Chargeurs’ demerger was well received from the start. Its shares climbed 20 percent in the months between the announcement in February, 1996 and the actual demerging of the companies last June, says Valais. He stresses that few of Chargeurs’ 20,000 shareholders questioned the company’s strategy.
Explanations, he says, ‘are not necessary when you do something and the result is immediate and very positive.’
When Thorn EMI demerged last August, its story was similar to Chargeurs. Thorn and EMI had joined forces in 1979, when both companies could exploit manufacturing efficiencies by merging. Jim Donovan, director of corporate affairs for Chertsey, UK-based Thorn plc, explains that over the years Thorn evolved into a consumer durables rental company, while EMI is an entertainment giant.
‘We had two companies in totally different markets with no business synergies between the two,’ says Donovan. From the time speculation about a demerger began until it took place, Thorn EMI’s share price rose from £9 to £15.
No Guarantee
In and of itself, news of a demerger is not enough to drive stock prices higher. For instance, General Instrument’s shares didn’t bounce after the technology company announced its intention to demerge earlier this year.
Jim Kedersha, telecommunications equipment analyst for Cowen & Company, explains that General Instrument’s demerger makes for simpler, cleaner analysis and more focused management, but doesn’t fundamentally change the value of the company’s parts: ‘You can’t go out there and say, Here’s the gut of a company that’s had a year and a half of tough earnings. Value it with the best of the companies in the industry.’
Mark Borman, General Instrument’s director of financial relations and planning, says that the pay-off from more focused management for each of the three separate companies won’t come immediately. ‘Everybody thinks it’s the right direction, but [stock performance] doesn’t happen instantaneously,’ says Borman. ‘If you could just create value by putting out a press release saying you’re splitting up, you’d find a lot more people doing it.’
Hitting the Ground Running
When Hanson said it would spin off four separate companies – US Industries, Millennium Chemicals, Imperial Tobacco, and The Energy Group – between June 1, 1996 and February 24, 1997, keeping only the building materials business, some investors were hostile to the idea. They questioned why a company that had billed itself as benefiting from skilled, central management and aggressive acquisitions would want to spin off its component businesses. ‘Intrinsically, I think there was a lot of skepticism on whether the parts were worth more than the whole,’ says Aviva Gershuny-Roth, now head of corporate communications for The Energy Group.
Reactions were divided by continent. US investors tended to embrace the demerger, while Hanson came under fire in the UK, according to Justin Read, who heads the UK investor relations department. He explains why: ‘The US is more used to the concept of demergers and was quicker to appreciate the potential for the companies.’ Read maintains that ‘the financial community [in the UK] concentrated on the costs of the demerger without the experience of looking at the benefits.’
Patricia DeFelice, Hanson’s IR director in the US, says that American investors were generally sympathetic to Hanson’s strategy of demerging to focus management in its businesses and promote growth. On the other hand, DeFelice believes that UK investors were alarmed that the broken-up companies would no longer enjoy the same attractive tax benefits, nor would some of the new companies pay the high dividend expected of the old Hanson conglomerate.
‘In the UK, they’re very dividend oriented,’ says DeFelice. ‘The demerger scared the hell out of all the yield funds over there.’
Demergers can wreak havoc on IR offices, which must cope with an avalanche of calls from individual investors confused by the change. DeFelice recalls that in February, when The Energy Group was demerged from Hanson and Hanson’s stock underwent a reverse split, the company’s US operations, including the automated 1-800 line and outside information agent, received a total of 12,900 calls, 8,800 of them during the week of the demerger alone.
Besides coping with a flurry of bewildered investors, newly demerged companies must quickly establish a corporate identity, set up their own IR departments, plan shareholder meetings, design an annual report, and contact analysts and potential investors.
Hanson’s spin-off of Millennium Chemicals on October 1, 1996 meant that a separate corporate office had to be established. Although DeFelice says the head count remained the same, she took over Hanson’s IR function, while Mickey Foster became VP of IR for Millennium.
Because Hanson is publicly-listed in both the UK and the US, Millennium faced an added challenge: replacing UK shareholders who defected after the demerger. ‘UK investors tend not to like a chemical company listed only on the New York Stock Exchange that pays a small dividend,’ says Foster. ‘Basically, on the day of the spin, two thirds of [Millennium] shares were held in London and today about one third are.’
Gaining analyst coverage for the newly-demerged company is another task awaiting the IR department. Though most analysts initiate coverage on their own, they may need more hand-holding because the company is unfamiliar to them. The good news is that analysts tend to get up to speed quickly, says General Instrument’s Mark Borman, who doesn’t expect his company’s demerger to prove too nettlesome for analysts. ‘It isn’t really that difficult for the financial community to grasp,’ he says. ‘In fact, it simplifies the story.’
Skeptical Audience
IROs in demerging companies understand that their message may be greeted with a healthy dose of skepticism. The challenge, they say, is to encourage short-term-oriented analysts and portfolio managers to take a wait-and-see approach.
‘It’s all very well to say what you’re going to do,’ says Gershuny-Roth of The Energy Group. ‘But until we announce results that show the story we told was true, it’s going to take time for the market to believe us.’ Gershuny-Roth points out that shares of three of Hanson’s demerged companies – US Industries, Imperial Tobacco, and The Energy Group – have already performed quite well. She maintains that share price problems at Millennium are attributable to the idiosyncrasies of the chemicals industry, and that even Hanson stock, which was buffeted about during the demerger, began showing signs of a rebound this spring, when its shares began trading above £3.
Is it true that good things come in small, spun-off packages? The answer most IROs would give is ‘yes and no.’ Demerging may be a smart strategy for an unwieldy giant, but the main benefits come from how management runs the demerged entities in the future. Gershuny-Roth, for instance, is confident that twelve-to-18 months from now, the wisdom of Hanson’s demerger will be borne out by the individual performance of the separate companies.
Hanson’s Read sends a similar message, emphasizing that the demerger is by no means the end of the story. ‘The demerger is not behind us,’ concludes Read. ‘There’s still an educative role to perform and a lot of people to sell the story to. The job of communicating about the demerged companies is just beginning.’
High-Tech Campaign
How a company announces a demerger can make an indelible impression on analysts, portfolio managers, and individual investors. Knowing this, Mark Borman, General Instrument’s financial relations director, chose an unusual, high-tech approach for disclosing the Chicago-based technology company’s plans to demerge this summer.
General Instrument synchronized its face-to-face announcement at the St Regis Hotel in midtown Manhattan with a conference call for the financial community, satellite hook-ups for employees, closed-circuit video for brokerage houses, and a presentation on the World Wide Web.
‘The announcement date is the first day of the demerged company’s life,’ says Jeff Zilka, senior managing director of Hill & Knowlton and an advisor to General Instrument. Unlike other corporate communiques, ‘This is not an announcement that has to be made on a specific date,’ says Zilka. ‘You can plan for it.’
Three months before the announcement, General Instrument began considering how to tell shareholders that it wanted to restructure General Instrument into three separate, publicly-traded companies: NextLevel Systems, the cable, satellite, telephony, and Internet/data networking businesses; CommScope, a world leader in coaxial and electronic cables; and General Semiconductor, a major supplier of power rectifiers and transient voltage suppressors. The demerger was planned to take place in June.
Borman recalls that General Instrument promised a ‘big news event’ at the January 7, 1997, stockholder meeting, but the news itself remained top secret. At 4 am on the day of the demerger announcement, Borman started faxing plans for the demerger to analysts, institutions, and the media; he simultaneously placed the news on the Web (www.gi.com).
The demerger message was simple and consistent. Given that all three of General Instrument’s businesses have decentralized management and very different business characteristics, a demerger would allow management to focus on essentials and create more targeted incentives.
To preserve secrecy while planning a carefully-timed Web release, General Instrument created a sub-site that would only be revealed on the day of the announcement, says Dick Badler, General Instrument’s VP of corporate communications. Included on that Web site were NextLevel’s new logo and overheads for the IR meeting.
Zilka emphasizes that the announcement of a demerger is a one-time opportunity to influence how analysts and institutions will view the new companies. Because companies undergoing a demerger usually feel that certain businesses have lacked visibility, this is the chance to cast the businesses in a more appealing light. Zilka advises attending to all details, from characterizing the new companies as yield or growth businesses to preparing fact sheets that clarify the overall business mix.
The aim of the announcement, according to Zilka, is to convince ‘the financial community to give a thumbs up on the demerger. Once you’ve made your announcement, then you can hit the road and sell it.’
