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    The preferred playbook for many of the largest, most profitable companies has been growth through acquisition. But sometimes companies need to shrink to grow, and a spin-off often can be the cornerstone of a strategic transformation.

    In a recent analysis of more than 100 spin-offs with distribution values of $1 billion or more and closing dates between January 2001 and December 2018 , Barclays’ M&A Structuring team found that successful spin-offs offer more than a bump in trading multiple. Specifically, the heightened clarity, focus and strategic flexibility derived from a spin-off can drive long-term value for both the Parent and the newly formed SpinCo.

    In this 3 Point Perspective, we explain why spin-offs, while not a one-size-fits-all strategy, represent one of the most powerful and investor-friendly transaction structures available to public companies.

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    Spin-offs deliver a new gear for earnings growth

    Investors and corporate leaders are often quick to make assumptions about when spin-offs make sense, drawing on the notion that they are most appropriate for stagnant or mature businesses. But in its analysis, the Barclays M&A Structuring Team found that nearly 60% of the spun-off companies traded at a multiple greater than their parent company post-transaction, and about half had margins exceeding those of their parent.

    Further, Barclays found that spin-offs can create meaningful operating upside for parent companies and newly formed companies alike. In the analysis, the median earnings per share (EPS) estimate of the two separate entities increased 20% relative to estimates prior to the transaction. For “win, win” transactions – where parents and spin-offs had positive relative performance post-spin – estimates increased by nearly 50%.

    More than a third of spin-offs analysed resulted in better relative Total Shareholder Returns for both ParentCos and SpinCos

    Scatter plot graph showing 100+ spin-off deals arranged by Total Shareholder Return performance

    Source: CapitalIQ, Barclays M&A Structuring

    What about multiples? While spin-offs can pave the way for increased profitability, they may not drive a significant uptick in multiples. In fact, the median change in parent companies’ price to earnings (P/E) multiple was only nine percent, and, among “win-win” transactions, nearly 30% of parent companies experienced multiple contraction after the deal.

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    Spins offer upside in many markets across many scenarios

    Relative to other strategic transactions, spin-offs can offer upside in the broadest context: they are largely industry-agnostic, and they can work in nearly all market environments. The main exceptions are deals that close prior to periods of seismic industry change, such as financial services spins ahead of the 2008 crisis and energy spins ahead of the 2014 to 2016 oil price plunge. Even in those extreme cases, the spin-off process provides flexibility to push pause or pivot should market conditions change or better options materialise.

    Meanwhile, transaction fees are typically lower than for other deals, and spin-offs often result in improved capital structures. What’s more, they typically benefit a broad group of stakeholders, including investors, customers and employees.

    There is no template or required set of portfolio characteristics for a spin-off to be successful. Deals in the “win-win” quadrant included strong Parent companies and strong SpinCos; strong Parents and weaker SpinCos; and weaker Parents and stronger SpinCos.

    The data reinforces that spin-offs are a highly versatile and flexible tool that can help a range of companies across sectors unlock option value embedded in a diverse set of businesses.
    Richard Casavechia, Global Chairman, Investment Banking, and Head of M&A Structuring
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    Unsuccessful spin-offs share common themes

    While there is no strict formula for a successful spin-off, the analysis revealed commonalities among spin-offs that missed the mark. By isolating the “lose-lose” transactions – where both entities had poor relative performance post-transaction – the following themes emerged:

    • They tend to be smaller transactions. The distribution values of “lose-lose” SpinCos were approximately 10% to 15% smaller than those of successful spins.
    • They lack future growth. The “lose-lose” transactions were the only group that saw standalone EPS estimates decline for the independent companies relative to pre-transaction consolidated estimates.
    • They have weaker margin profiles. The median margin characteristics are slightly below the other transactions.
    • They are more prone to multiple contraction. Although the median P/E mimics the broader set of transactions analysed, a greater percentage (nearly half) of parent companies experience multiple contraction.

    Systemic market events notwithstanding, underperformance ultimately can be attributed to two main factors: First, the SpinCo started with a suboptimal capital structure that made it difficult to support debt service and drive earnings growth; second, both the SpinCo and the Parent were subscale in their relevant industries and lacked a “second step” strategic action to help them improve their competitiveness and grow as focused businesses.

    What about the winners? In more than half of the 20 largest “win-win” transactions, the spin-off was part of a larger strategic plan that typically included increased growth investment and further portfolio actions, including acquisitions, divestitures or additional spins. Corporates considering strategic alternatives should assess their circumstances against the win-win traits of past spin-offs.

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    About the expert

    Richard Casavechia is a Global Chairman of Investment Banking and Head of M&A Structuring at Barclays. He advises clients on a broad range of acquisition and disposition strategies. Prior to joining Barclays, Richard spent almost nine years at Bank of America Merrill Lynch, where he was head of the firm’s M&A Structuring business, and he spent nine years at J.P. Morgan as the Global Head of M&A Tax Advisory. He also worked as a tax attorney, most recently at Cahill Gordon & Reindel.

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