JUNE 2015

Shrinking to grow
Evolving trends in corporate spin-offs
Published by Corporate Finance Advisory
For questions or further information,
please contact:
Corporate Finance Advisory
Marc Zenner
marc.zenner@jpmorgan.com
(212) 834-4330
Evan Junek
evan.a.junek@jpmorgan.com
(212) 834-5110
Ram Chivukula
ram.chivukula@jpmorgan.com
(212) 622-5682
 SHRINKING TO GROW: EVOLVING TRENDS IN CORPORATE SPIN-OFFS | 1

1. Spin-offs are coming

Corporate focus is “in.” In ever greater numbers, firms have been announcing spin-offs.
With historically strong balance sheets, most firms are not divesting to finance growth or
reduce leverage. Rather, they are spinning off and divesting to achieve the valuation benefits
commonly associated with corporate focus and clarity. The pace of corporate separation
announcements has rebounded significantly since the end of the financial crisis, highlighted
by recent front page announcements by blue chip firms. The pace of separations by S&P 500
firms over the last few years has exceeded the level of any period since 2000 (Figure 1).
Figure 1

The pace of separation announcements by S&P 500 companies has rebounded

15 per year

12 per year

7 per year
6 per year

4 per year

Post-dot com recovery Pre-crisis peak Crisis lows Making of a recovery Dawn of a new era
(2000—2004) (2005—2007) (2008—2009) (2010—2012) (2013—2015 Q1)

Source: J.P. Morgan, Bloomberg as of 3/31/2015

Note: Includes all spin-off and split-off announcements of S&P 500 firms excluding RMT transactions and cancelled deals;
2015 based on annualized figure

While capital markets observers recognize that the number of spin-offs has increased
materially, and that investors have generally responded well to spin-off announcements,
the remarkable differences between yesterday’s and today’s spin-offs are not often
well understood. As we show in Figure 2, S&P 500 firms are now spinning off smaller,
lower-rated firms and, not surprisingly, spin-off decisions are now more likely to be
driven by activists than in years past. Recent spin-offs are also more likely to include
innovative structures, such as Reverse Morris Trusts (RMTs), cash-rich split-offs, retained
shares, etc., suggesting that senior executives leave no stone unturned in their quest to
create value.
2 | Corporate Finance Advisory

Figure 2

The spin-off landscape has evolved considerably in recent years

2010—2012 2013—2015 Q1
Percentage of deals in which activists were catalysts 14% 36%

Percentage of deals with an innovative structure1 10% 25%

Median size of SpinCo2 $4.0bn $2.5bn

Percentage of SpinCos included in the S&P 5002 57% 6%

Percentage of SpinCos that are investment grade rated2 38% 22%

Source: J.P. Morgan, Bloomberg, CapitallQ, FactSet

1
Innovative structures include Reverse Morris Trust (RMT) transactions, cash-rich split-offs, carve-outs, retained shares
structures
2
Throughout this report, SpinCo refers to the spun-off company and RemainCo refers to the entity remaining after the
spin-off

Many factors have driven this major shift in the nature of spin-offs, but they all arise
from the current low interest rate environment. Low rates are leading to more and smaller
spin-offs due to the following factors:
• The cost of capital benefits of investment grade capital structures are currently less
pronounced than they have been historically (except in commodity-oriented sectors)
• Non-investment grade capital markets offer debt at record-low cost
• Investors have an appetite for both yield-driven equity (e.g., REITs, MLPs, high dividend
stocks) and growth stocks; spin-offs often provide an opportunity to target investor
clienteles
• Firms enjoy strong access to capital markets and do not need to sell assets to reduce
leverage
• Activist hedge funds present attractive investment alternatives in low-rate environments
like today and, with their ever increasing assets under management, often pressure firms
to spin off their non-core divisions

EXECUTIVE TAKEAWAY

Spin-off activity has rebounded significantly

since the financial crisis. Supportive capital
markets and activist investors seeking
new value-creation alternatives have been
catalysts for this revival. In contrast to prior
periods, today’s spin-offs are smaller, more
likely to be non-investment grade and
less likely to be in the S&P 500 index than
previously. With this backdrop, boards and
senior decision-makers are encouraged to
be proactive in evaluating the attractiveness
of a separation or the opportunity to acquire
recently spun-off firms. While spin-offs have
undoubtedly created shareholder value, a
careful cost-benefit analysis is still necessary
before a spin-off decision is made.
 SHRINKING TO GROW: EVOLVING TRENDS IN CORPORATE SPIN-OFFS | 3

2. Firms executing spins typically outperform in both the

short- and long-term
Anticipating the potential benefits of corporate separations, investors have historically
rewarded companies announcing spin-offs. These firms have experienced positive reactions
across sectors and company size. More importantly, these announcements are well-received
both over the short- and long-term. Upon announcement, the market-adjusted reaction is a
2-4% upswing for the parent company. Intriguingly, this figure (measured post-spin as the
combined return of the RemainCo and SpinCo) rises to 15%-20% over the subsequent two
years (Figure 3). These numbers suggest that the recent wave of separation announcements
has the potential to create value of approximately $300bn, approximately 2% of the market
capitalization of all U.S. firms. This outperformance is in addition to any pre-announcement
rise in stock price due to investor anticipation of such a transaction (for example when the
market hears either through rumor or by a formal statement that a firm is examining the
pros and cons of a separation). Note that while the initial reactions are material, on average
they are a fraction of the eventual long-term value creation. The market may not fully price
in all the advantages accruing from the spin, either because of insufficient information or
due to a lack of confidence in the successful execution of the spin-off and the harvest of its
potential benefits.
Figure 3

Parents and RemainCos + SpinCos tend to outperform both in the short-run and long-run

18% Average time until spin completion Value creation potential2

16% $312bn
16%
14%
Post-spin
12% $150bn excess
Excess returns

10% return: 8%
8%
6% $98bn Pre-spin
4% 3% excess
2% $64bn return: 8%
0%
0 100 200 300 400 500

Trading days post-announcement

Source: J.P. Morgan, FactSet, Company Filings, Bloomberg as of 3/31/2015
Note: Includes all spin-off and split-off announcements by S&P 500 firms with size greater than $500mm and at least two
years since announcement, excluding RMT transactions and canceled deals
1
Market reaction based on the total return in company stock less beta * total return on the S&P 500; compound total
return is based on price appreciation with dividends reinvested by default on the exdate
2
Value creation potential is based on average excess return and pre-announcement equity value for all announced
spin-offs since 2009; actual realized value creation for all completed spin-offs since 2009 with at least two years since
announcement was $106bn

A common misperception of separations is that the value creation comes from the
independence of high-growth subsidiaries. One would, therefore, expect that the separation
of a high-growth subsidiary would lead to a decline in the valuation multiple of the RemainCo
relative to the parent company (Figure 4, left panel). This intuition does not, however,
play out in practice. We find that the valuation multiples of both RemainCo and SpinCo
increase relative to the pre-spin company (Figure 4, right panel). We estimate the uptick in
valuation multiples post-separation to be over 20%. Admittedly, broader market multiples
also increased during that period, but after controlling for this general uplift in multiples, we
still find the difference to be material, remaining in the 10%–20% range.
4 | Corporate Finance Advisory

Figure 4

A significant source of the long-term value creation comes from multiple expansion

Expected Actual (EV/EBITDA) Pre-spin to post-spin:

Firm: +22%
S&P 500: +8%
Multiple
expansion
8.6x 8.3x
8.0x 1.3x Excess
Multiple 0.6x 0.9x expansion
erosion 6.9x 0.5x 0.5x 0.5x General
market
expansion

6.9x 6.9x 6.9x 6.9x

Pre-spin RemainCo SpinCo Post-spin Pre-spin RemainCo SpinCo Post-spin

weighted weighted
average average
Pre-spin Post-spin Pre-spin Post-spin

Source: J.P. Morgan, FactSet, Bloomberg

Note: Includes all completed spin-off deals since 2009 by S&P 500 firms with size greater than $500mm and at least
six months since completion; figures refer to median of deals; analysis based on next 12-month multiples based on IBES
consensus estimates

Several factors may explain this multiple expansion, including:

• Increased business line transparency
• Enhanced growth expectations
• More attractive acquisition currency (or more attractive target)
• Clearer alignment of management incentives
• Growth/risk/capital allocation profile tailored to differing investor preferences
and clienteles
This last point has become particularly important because the ongoing low interest rate
environment has driven investors to yield-oriented equity securities. The increasing trend
of firms spinning off REITs and other yield-oriented entities is one example of how this
phenomenon has manifested itself.

EXECUTIVE TAKEAWAY

Investors continue to embrace firms

announcing separations, not only in the
short-term but also over the long-term. The
returns are largely attributable to the higher
valuation multiples that both the RemainCo
and SpinCo command after the spin-off.
There is dispersion in the data, however,
and firms announcing separations should
have clear plans with a credible execution
strategy to maximize investor reception to
the transaction. In our experience, where
such a strategy was not available, firms have
typically declined to pursue spin-offs as an
avenue for creating value shareholder.
 SHRINKING TO GROW: EVOLVING TRENDS IN CORPORATE SPIN-OFFS | 5

3. From conglomerate discount to focus premium

Firms with operations spanning disparate sectors (such as energy, banking and retail) have
historically traded at a discount to stand-alone peers. This discount has been referred to as
the “conglomerate discount” and has been well-documented. Interestingly, the nature of
the valuation differential has evolved in recent years to now encompass firms operating
in segments in the same general sector (such as operating in various subsectors within
technology or branded food). With greater investable wealth and more technological
resources, today’s investors tend to seek greater optionality in portfolio creation. As a result,
investors now place a premium on firms targeting narrower subsectors within a broader
industry. We refer to this preference as the “focus premium” (Figure 5).
Figure 5

Evolving investor preferences give rise to a “focus premium”

Historically Today

Conglomerate discount Focus premium

Segment A Segment A Segment A1

Segment B Segment B Segment A2

Segment C Segment C

Source: J.P. Morgan

The focus premium captures the valuation benefit attributed to firms, even those wholly
in a particular sector, with a more concentrated focus. We compute it as the percentage
difference in the median P/E ratios between firms with 1–3 segments and those with 4+
segments (as illustrated in Figure 6). As expected, the focus premium is generally correlated
with spin-off activity. Spin-off activity and the focus premium have been elevated in recent
years, indicating that firms proactively contemplating separations can benefit from
investor preferences.
6 | Corporate Finance Advisory

Figure 6

The focus premium indicates strong investor appetite for corporate clarity

14%

6%
3%
1%

Pre-crisis peak Crisis lows Making of a recovery Dawn of a new era

(2005–2007) (2008–2009) (2010–2012) (2013–2015 Q1)

Source: J.P. Morgan, Bloomberg, FactSet

Note: The focus premium is computed, for S&P 500 firms, as the % difference in the median EV/EBITDA ratios between
firms with 1—3 and 4+ “key” segments. “Key” segments are those that: (i) do not have the word “other” in their name
and (ii) have at least $1bn in revenue or 10% of total revenue

EXECUTIVE TAKEAWAY

Firms operating in what traditionally

seem to be related areas and hence
unaffected by the conglomerate discount
are now turning to spin-offs as a method to
capture the focus premium. This premium
has risen sharply in the past few years,
suggesting that investors currently reward
corporate clarity more than they have in
the past.
 SHRINKING TO GROW: EVOLVING TRENDS IN CORPORATE SPIN-OFFS | 7

4. Structural innovations continue to evolve

As firms have continued to embrace the theme of corporate clarity, separation strategies
have generally become more sophisticated and innovative, with Figure 7 illustrating a few
popular approaches. For example, Reverse Morris Trust (RMT) transactions, essentially a
spin-off coupled with a merger, have doubled, reflecting the positive trends in both corporate
clarity and M&A.
Similarly, carve-outs, where firms first “IPO” the entity to be subsequently spun or split off to
shareholders, have also seen an uptick in popularity. This approach provides RemainCo with
additional firepower to maximize benefits arising from the focus premium. Retained shares
structures, whereby firms keep a stake in the SpinCo equity for later sell-down have emerged
as a common alternative to the carve-out structure, without much of the associated market
timing and risk associated with an IPO. Cash-rich splits, whereby firms contribute assets
and cash to a subsidiary which is subsequently exchanged for shares of the parent company,
effectively resulting in a buyback of parent company shares, have also been more frequent.
Not all structures have seen a significant pick-up in activity, however. Debt-for-debt exchanges
—whereby firms may tax-efficiently monetize an asset in a spin-off above tax basis—have
declined from five in 2010–2012 to just one since. This trend has been driven by a 2013 IRS
proclamation that significantly complicates debt-for-debt transactions.
There are many tools that provide firms contemplating separations with additional flexibility
to raise funds, optimize their capital structures, and seek strategic and valuation benefits in
conjunction with greater corporate clarity. The evolving use of these structures underscores
the willingness to pursue more complex strategies to maximize shareholder value creation.
Figure 7

Separation transactions have increasingly used various structural innovations

2010—2012 2013—Q1 2015

6
5
4 4
3 3
2
1
0 0
Cash-rich splits Retained shares Carve-out spins Reverse Morris Trusts Debt-for-debt exchanges

Source: J.P. Morgan, Bloomberg as of 3/31/2015

Note: Includes all spin-off and split-off announcements of S&P 500 firms; cash-rich split defined as split co-asset value
consisting of at least one-third cash

EXECUTIVE TAKEAWAY

Firms evaluating potential separations

have numerous tools at their disposal
to maximize both the strategic and
monetization potential of separations. The
evolving use of these techniques suggests
firms are more willing to subject themselves
to modestly greater complexity to create
more shareholder value.
8 | Corporate Finance Advisory

5. Strike the iron while it’s hot

A confluence of economic factors is driving the resurgence in separation activity today:
primarily a sluggish growth environment, low interest rates and attractive capital markets
(Figure 8). In addition, the focus premium is at an all-time high, drawing the attention of
both traditional and activist investors. Accordingly, management teams, even of firms that
operate in one general sector, should continue to assess the value-creation potential from
spin-offs. Assuming value can be ascertained, these senior decision-makers should then
actively discuss the pros and cons of a separation with their boards.
We caution, however, that not all spin-offs are created equal. Despite investor pressures
for more spin-off activity, boards and management teams, in conjunction with their
financial advisors, should continue to consider both the short-term and long-term value
benefits of separations. Separations are associated with friction costs, and if the value
benefits are low or short-lived, the decision not to separate may create more long-term
value. In cyclical sectors, a return to more volatile capital market environments may make
spin-offs less attractive. In those sectors, it is important to evaluate the benefits of a spin-off
through the economic cycle.
Figure 8

A historic time for corporate separations

Catalyst Present historically Present today

Equity investor preference for focus

Low-growth environment

Dividend premium

Supportive high yield debt capital markets

Activist pressure

Willingness to explore new structures

Source: J.P. Morgan

Investors today understand that economic factors are uniquely conducive to separations and expect
companies to take advantage of these conditions. This environment indicates that at the very least,
firms should explore whether some of their businesses would perform better, or at a minimum
be valued more, on a stand-alone basis. Potential operating and financial synergies of combined
businesses, whether across or within sectors, are often smaller than expected. When that fact pattern
is present, it can be worth capitalizing on supportive economic and corporate finance conditions
while simultaneously satisfying investor expectations. Further, decision-makers should also ensure
that a separation guarantees value creation in both the short and long run. This is imperative because
separations are associated with friction costs, and not all possible separations are created equal.
 SHRINKING TO GROW: EVOLVING TRENDS IN CORPORATE SPIN-OFFS | 9

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