Chapter 1
The Epidemic Breaks Out
The evidence that breakups work could scarcely be clearer...the average spinoff performed 25 percent better than the stock market in the first 18 months after breakup.
Spin-offs, JP Morgan
In a short time, breakup has become a major force, growing with apparently relentless vigor.
Spin-offs, JP Morgan
The breakup phenomenon is not new. The US tax rules by which spinoff transactions are structured were written in 1954. But large-scale breakups are more recent than that, only becoming significant in the 1980s. The first really big breakup occurred in 1982-83 when the US government won its antitrust suit against AT&T AT&T had been America's largest industrial company, enjoying a monopoly of local and long-distance telephone services and of the supply of telephone equipment. Ma Bell was broken up into seven separate Baby Bells, regional local call providers, leaving AT&T with long-distance and international calls, the Bell Telephone research labs, and its telephone manufacturing business.
THE ESCALATION OF BREAKUP IN THE US
The escalating value of US breakup transactions can be seen from Figure 3. Excluding the AT&T deal, the value of breakoffs averaged only $1.1 billion each year during the period 1980-84; for 1985-89, this average jumped over five times to $6.1 billion; and for the 1990-94 period, it leapt further to an average of $14.8 billion. In 1995 we saw a tidal wave of breakoffs, with a total value of $76.7 billion, two and a half times the 1994 level (itself a previous record), and five times the average of the early 1990s. The compound annual growth rate of the value of breakoffs from 1991 to 1995 was a staggering 104 percent. Growth continued in 1996; just two breakups -- that of Lucent from AT&T, and EDS from General Motors -- have accounted for almost $50 billion on their own.
The importance of breakups can also be measured relative to the total value of all corporate divestitures. As Figure 4 shows, breakoffs only became an important method of disposal in the early 1990s. Breakoffs as a proportion of the total then grew explosively, to reach 37 percent of the total in 1995.
BRITAIN JOINS IN THE BREAKUP PHENOMENON
Breakoffs are also important on the other side of the Atlantic. Breakoffs began rather later in the UK, with two transactions in 1987 and four in 1988. They only became significant in value terms in 1989, when seven deals totaled $3.9 billion, compared with a US figure of $10.1 billion for that year. Thereafter, the value of transactions has shown no real trend (see Figure 5). The number of UK transactions has remained in single figures each year, but includes some very large individual deals, especially the demerger of Zeneca, the life sciences business, from the chemical company ICI in 1992.
You can see from Figure 6 that UK breakoffs have become an important, though highly fluctuating, component in the total value of all divestitures, ranging from less than 1 percent in 1994 to 34 percent the previous year; the average is a shade over 10 percent.
What has happened to the number of deals and their average value?
The total number of transactions has also increased, though not as fast as the value. The numbers of breakoffs in the US and UK can be seen in Figure 7, and their average value in Figure 8.
The average size of American breakup transactions has risen steadily in the 1990s, from $170 million in 1990 to over $1 billion in 1995. In the UK, there has been no trend in the average value of deals: it fluctuated from $3.5 billion in 1992 (as a result of the huge ICI/Zeneca demerger) to $4 million in 1994. It is important to note, however, that in both the UK and the US, there have been very large breakups and also a number of much smaller ones. In America, transactions in excess of $500 million typically constitute only about 20 percent of total transactions, varying fairly consistently within the 10 to 30 percent band.
DO BREAKUPS WORK?
Yes! The evidence that breakups work could scarcely be clearer. In a 1995 note entitled Spin-offs, international investment bank JP Morgan looked at the stock-market performance of 77 spin-offs since their independence. As shown in Figure 9, the average spin-off performed 25 percent better than the stock market during the first 18 months after breakup. Tellingly, the outperformance also increased steadily over time, so that it is probable that future research, allowing a longer period after breakup, will show significantly greater outperformance.
There is also some evidence for superior returns by parent companies after the spin-off.
Jp Morgan undertook an analysis of the post-spin-off share price performance of those transactions involving at least $850 million in market value and 20 percent of the parent's pretransaction value. This subsample outperformed the market by 18 percent in the first year after the spin-off. In Morgan's words, "it appears that the remaining slimmer parent company, on average, does materially better than the market following the separation."
In other words, where the spin-off is significant, the combined entity has outperformed the market by around 20 percent.
JP Morgan's study generated the even more fascinating result that smaller breakups performed still better. The study grouped the spin-offs into two segments: those with an initial market capitalization under $200 million, and those above. We can see from Figure 10 that the outperformance of the larger spin-offs was around 13 percent, but the smaller spin-offs beat the market by a staggering 45 percent and the trend was still sharply upward.
The significance of this finding has yet to sink in. If smaller breakups are actually so beneficial, there should be many more of them. If there are many more of them, the importance and value of breakups will rise even faster in the future than they have in the past. Especially in the UK, where there have been comparatively few breakups, and most of their value has been concentrated in a very small number of large deals, there is great potential for many more smaller breakups.
It should be remembered that share price movements can stretch out over a long period of time:
* Often there is a rumor that something is going to happen; it can be just a guess or even a suggestion by a journalist or a security analyst; if the market takes it seriously, the first price reaction occurs.
* Sometimes events that are typical precursors of a breakup can similarly cause movement in the price, especially if an active investor takes a stake in the company.
* The announcement itself typically leads to another jump in the price.
* Following the actual spin-off, more price movement generally occurs.
The data in Figures 9 and 10 refer only to price movements after the spin-off has been completed. Research into price movements before completion suggests that they double the 20 percent or so uplift that happens after completion.
BREAKUPS IN THE UNITED STATES: LANDMARK EVENTS
There have been twenty particularly significant cases in recent US history, involving seventeen companies. These are summarized in Figure 11.
Some recent highlights:
In June 1995, Rand Araskog shocks and delights Wall Street by announcing a breakup of ITT Corporation into three more focused corporations: ITT Hartford Group (insurance); ITT Industries (automotive, military, and electronics); and ITT Destinations (hotels, gambling, entertainment, and information). The breakup proposal is a huge volte-face for America's most diversified conglomerate.
Three months later, AT&T announces another three-way split (a "trivestiture"), this time into communications, communications hardware, and computers.
In 1996, General Motors announced the spin-off of EDS, its information syst
