The world’s second-richest man devoted a chunk of his annual letter to Berkshire Hathaway Inc. shareholders to defending the company’s conglomerate structure—and to criticizing other companies’ spin-offs, Bloomberg noted. Buffett denounced the deal structure in which a fee-hungry “banking fraternity” urges acquisitions, only later to encourage their undoing for the sake of “unlocking shareholder value.”
But in an uncommon departure, the market at large seems not only to be disagreeing with Buffett, but ignoring his criticism. Bloomberg reports there has been a record number of spinoffs in the last 12 months as companies try to maximize overall performance by autonomizing units that may be stuck under an umbrella of diverse corporate assets—some that may be mature while others are in a growth phase, and some that are doing poorly while others are doing well.
The spin-offs have included large companies, such as drugmaker AbbVie’s split from Abbott Laboratories. And more are on the docket, such as Anglo-Australian mining giant BHP Billiton’s plan to carve off better-performing assets such as nickel pits to focus on four commodities, including iron ore and oil, the prices of which halved in value last year. Activist investor Third Point Capital has been after Dow Chemical to split up, while Darden caved into the wishes of activist investor Starboard Value late last year after the sale of Red Lobster.
“Proof is in the pudding,” because spin-off stocks have “smoked the S&P 500,” Joe Cornell, an analyst for Spin-Off Advisors in Chicago, told Bloomberg.
Spin-offs can be a masterful choice for capital allocation by savvy CEOs who decide to shrink their companies for maximum shareholder value rather than make them bigger, said Ken Skarbeck, managing partner of Indianapolis-based Aldebaran Capital.
How can CEOs ensure that a spinoff is the best decision for their firm? They should ask themselves four questions, according to Herman Vantrappen, managing director of Akordeon, a strategic advisory firm based in Brussels, and Enrico Polastro, vice president at Arthur D. Little, who wrote in Harvard Business Review:
Is the business ready to stand on its own feet? Reducing parental dependence is key, using a careful roadmap that details, among other things, how the spun-off unit will become autonomous in terms of revenues and central services—especially for carve-outs that aren’t full-fledged business units.
Does the business have a complete, balanced and cohesive management team? Successful spin-offs include managers who are insiders and outsiders, the two write, and should be “[bound] together into a cohesive group with fully aligned objectives.”
Are the management team and owners prepared to abandon business as usual? The spin-off event is “just the beginning of a journey that will be radically different from the past,“ Vantrappen and Polastro remind HBR readers. “Only in rare circumstances is ‘business as usual’ a viable value-creating option.”
Does the business have an adequate financial structure? The new company needs to be able to bridge the transition period to full independence and to implement their new strategy.
If CEOs are going to thumb their noses at the philosophy of Warren Buffett, they’d better be able to make a great case. Answering these four questions adequately will put them on that road.