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Why are Major Conglomerates Suddenly Splitting Up into New Corporate Entities?

Conglomerates Suddenly Splitting Up into New Corporate Entities - TechSci Research

Consulting | Nov, 2021

There has been a crazy new trend of ginormous global companies dismantling into multiple entities as diversification isn’t a rage in the corporate world. Companies like Johnson & Johnson, GE, Pfizer, Merck, GlaxoSmithKline have recently announced their corporate divorces, but the splits are not confined to the healthcare sector. Many tech giants, global retail brands, telecom companies have spun off large divisions so that they can invest their time and focus on the most profitable lines of their business. The corporate split will make each business nimbler in adapting to their respective markets, enable better allocation of capital, and allow better management to make better strategic decisions. Some companies may choose to spin off divisions to provide them greater autonomy and forge better business relationships, which are otherwise made by the colossal conglomerate.


GE Split Marks the End of Conglomerate Era

The largest company by market capitalization, General Electric (GE), is splitting itself into three public units, one for aviation, one for healthcare, and another for building energy products. The industrial powerhouse that once hedged risks by diversifying profit centers is now splitting its entities. The aim is to enable greater focus, tailor capital allocation, and allow strategic flexibility to drive long-term growth while creating higher value for customers, investors, and employees. GE’s breakup of entities has become emblematic of the waning attraction of conglomerate business structure that defined much of the 20th century corporate America. GE healthcare branch would provide more focus on precision health while GE Renewable Energy would lead the energy transition from fossil fuels to clean energy, and GE Aviation would “shape the future of flights.” The independent business will appeal to a deeper investor base due to its unique position. Also, the transformation could help GE realize the full potential of each company.


Johnson & Johnson to Segregate Consumer Products and Pharmaceutical Businesses

Healthcare conglomerate Johnson & Johnson has planned to create two publicly traded companies, splitting its consumer products business from its pharmaceutical and medical device operations. The separation underscores the enhanced focus of J&J on key areas with unmet medical needs and leverage innovation to expand the standard of care and portfolio of life-saving therapies. J&J split is giving consumer brands such as Tylenol, Neutrogena, Band-Aid, Aveeno, and Listerine much-needed freedom to accommodate changing consumer preferences and economic trends. J&J identified a shift in how people connect to consumer products since the pandemic, often dictated by celebrity influence. The billion-dollar consumer units have untapped potential with highly attractive markets for self-care and wellness.


Toshiba Breaks Up After a Wave of Scandals

Japanese tech giant Toshiba has confirmed plans to take down its “comprehensive electronics manufacturer” shop sign and split the company into three separate businesses, focused on infrastructure and nuclear power generation, and semiconductor chip and memory device. The decision to break a significant entity established in 1875 comes after a series of scandals that shocked the world and tarnished Toshiba’s public image. The split will clarify corporate values and accelerate actions in management-related matters focusing on specialized business areas. Dismantling conglomerates is not a common business strategy, and it remains to be seen whether it will be successful enough to please activist investors. 


The motivations that compel gigantic corporations to split can vary significantly. Here are some of the main reasons why gigantic corporations decide to break up. 


Enhanced Management 

Skills, performance metrics, clients, and management logic are different for every enterprise. While executives are well-suited to one line of business, they might not have the expertise to oversee other companies. For instance, a specific unit may require more attention from the top management to lead to better profit margins and increased revenue. But, shifting focus on one entity might affect other businesses, which would again affect the overall performance of the conglomerate. The diversification of units under single management might not yield the desired results. Hence, spinoffs become a suitable alternative so that every business can grow to its full potential. By spinning off one or more divisions, management can eventually surpass stock value from what it could have otherwise received from a consolidated unit.


Giant food retail chain Mondelez International was formed as a spinoff from Kraft Foods Group in 2012 to focus on the growing global international snacks and confectionary segment. Today, Mondelez International has become a multi-billion dollar business with product lines including brands like Cadbury, Oreo, Ritz, Trident, Wheat Thins, etc. 


Hewlett Packard Enterprise (HPE) separated from Hewlett Packard for increased focus on IT, cloud, and software products. In fiscal year 2020, HPE reported USD27 billion in revenue while the other unit of HP enhanced focus on building personal computers and printer business.


  • Attract New Investors

Investors evaluate growing and mature businesses differently. When an organization is split into individual units, the investors in the parent company automatically become investors in the subsidiary unit through a tax-free distribution of new shares. In contrast, the new ones can purchase shares of one or both companies. Historically, spinoffs have been good for investors as both the parent company and subsidiary can outperform the market. Investors that can comprehend the unpredictability of the initial days and weeks experience much more significant gains. Investors wishing to take advantage of the spinoff must choose wisely between the parent company, subsidiary, or both. Aggressive investors usually invest in subsidiaries as the smaller company has more growth potential than a more established parent company. 


For instance, leading oil services company, TechnipFMC is anticipated to complete the spinoff of Technip Energies, which would lead to the separation of company’s core oil services business and its engineering and construction business. So, those who have invested in TechnipFMC will receive a distribution of 50.1%, while the parent company will retain the remaining shares.


  • Accurate Predictions 

Separating organizations into entities can result in higher quality research by the analysts covering those parent companies. According to a recent study, analyst forecast accuracy increases between 30-50% following a spinoff, which helps make better strategic decisions. Besides, when a corporation narrows down its array of businesses, it may attract coverage from security analysts who can provide better forecasts, ultimately benefiting the organization. 


  • Unlocking Shareholder Value 

The most significant driving factor for a corporate split off is the idea that the parent company is undervalued, either because of management, strategic, or other issues. Corporate’s spinoff one or more business units to increase the valuation of their remaining business. According to a study, the parent companies can see a 14% increase in their share value after a spinoff, while the spun-off companies can see a 22% increase in their share prices. Besides, the stock split sends a signal to the shareholders that the company’s share price has been increasing, so people invest in those shares, which lifts demand and prices. A company can reduce its share prices through stock splits to make the shares accessible to investors without undermining its value. 


According to FactSet Research Systems, spinoff activities of corporates in the past decade have been high in the US, reaching a valuation of USD654 billion in new companies. The wave in the capital markets pushing the companies to be smaller units has resulted in some fresh thinking of corporate restructuring. The frequent spinoffs would help dissipate an incredible amount of inertia against divestitures, offering unique examples of why the value of keeping businesses together can be less profiting than the value of breaking up companies. However, more fundamental recognition about the restructuring of companies is taking place, pushing companies to focus more on shareholder value creation with new entities. 


Way Ahead

The new entities formed after breakup from conglomerate will have more ability to allocate capital as per their priorities and become independent of embracing new opportunities without any encumbrance from the parent company. Besides, more focused companies perform better at mergers and acquisitions as compared to a more diversified company.

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