Learn about the advantages and disadvantages of demergers and divestitures for companies and shareholders.
Types of demerger or divestment
Benefits of demerger for companies
Benefits of demerger for shareholders
Disadvantages of demerger or divestment
Before we dive into the benefits of demergers, it’s necessary to acknowledge that there are different ways to demerge a business. There are therefore particular advantages and disadvantages associated with each type.
Types of demerger or divestment
In a demerger, part of a business is separated out and becomes its own company. The type of demerger impacts what happens to both the newly created company and also the parent. For the purposes of this article, the terms ‘demerger’, ‘divestment’ and ‘divestiture’ can be used interchangeably.
1. Spin offs
In a spin off, shares in the resultant company are distributed to existing shareholders of the parent via a dividend.
Learn more: Spin Off Company
2. Splits
Depending on whether it’s a split up or a split off, shareholders will either be given the opportunity to exchange their parent shares for new shares of the subsidiary, or the parent is liquidated into the new companies.
3. Carve outs
In a carve out, a portion of the shares of the subsidiary is sold to the public via IPO.
Learn more: Equity Carve Out
Advantages and benefits of demerger
Benefits of demerger for companies
1. Tax benefits
Legislation provides capital gains tax relief for shareholders and the company concerned. Spin offs can be non-taxable events. Split offs are also a tax-efficient way for the parent company to redeem shares.
2. Improved strategic focus
The most obvious benefit of a demerger is that separation brings about improved strategic focus. Removal of the parent company from the decision-making concerning the subsidiary allows for more agility in operations and for decisions to be made with closer proximity to the customer. For the parent company, a carve out is often (but not always) an opportunity to sell a non-core and potentially under-performing business unit.
3. Improved profitability
Large conglomerates are complicated and often inefficient beasts. Remove that complexity by creating separate companies and you can achieve an enormous amount of cost savings within more straightforward, focused businesses. This naturally leads to improved profitability.
4. Cash injection
In the case of a carve out demerger, the parent company can raise funds by selling a portion of the subsidiary’s shares via IPO, while retaining control. This capital injection can be used to invest in services central to the parent company’s business strategy. It also prevents the subsidiary from being purchased by a competitor.
Benefits of demerger for shareholders
1. Enhanced shareholder value
It’s possible to create significant shareholder value through a demerger. In fact, the general consensus among analysts is that demergers can be highly beneficial to the shareholders of both parent and NewCo—if planned and executed well.
For example, EY research between 2002 and 2017 into 124 global spin off transactions revealed that shareholder value was created as a result of certain factors, including speed of transaction completion and naming a candidate from the parent company as either CEO or CFO or both.
(*Success was defined as having delivered a total shareholder return one year after the spin that was higher than the parent company’s within the same period before the transaction.)
2. Long-term value creation
Even in instances where shareholder value is not created within the first year post-transaction, long-term growth is almost always an outcome. This is because shareholders of demerged companies can enjoy the benefits of more strategically focussed businesses with independent management accountability. This invariably results in increased share prices relative to if the demerger hadn’t happened.
3. Increased transparency
Demerger transactions create more transparency for investors, as visibility over operations and cash flow of the subsidiary is increased. This is a strong benefit, ultimately allowing investors to make better decisions.
Disadvantages of demerger or divestment
1. Shareholder dissent
There is always the possibility of shareholder churn if shareholders are against the demerger decision. In some cases, there is even a risk of shareholder lawsuits if the premium offered by ParentCo during a split off is deemed unfair.
2. Immediate drop in stock value
In a spin off, the price of shares in the parent company declines by the market value of the spun off business. However, it’s worth shareholders noting that disinvesting purely because of an announced demerger could mean missing out on some significant value in the future.
3. Requires significant planning
A demerger is an enormous undertaking and there is always a certain amount of execution risk. Separating a business requires considerable planning, almost always more than organizations imagine. So to maximize value, meticulous preparation is essential.
Accurate costings and values, for example, are difficult to achieve. Every aspect of the creation of the new company needs to be costed out, from the IT department to licenses and permissions. These figures can’t be overlooked because when it comes to IPO or a future trade sale, this is the first thing people will want to know when valuing the business.
Plan and execute your demerger with Ansarada
The Ansarada platform provides clarity, certainty and speed in business divestitures, restructures, mergers and acquisitions. Our divestiture data room software has facilitated some of the world’s most high profile and valuable deals.
Try it for free today
Frequently asked questions
What happens to shareholders in a demerger?
It depends what type of demerger it is. If it’s a split off, shareholders will get the opportunity to exchange their ParentCo shares for NewCo shares. If it’s a spin off, shares in the newly created company are distributed to existing ParentCo shareholders via a dividend.
How do demergers affect employees?
Demergers can be disruptive and cause stress for employees who feel vulnerable and not in control of their careers. So it’s important that corporate leaders give due consideration to how the human impact of a demerger can be minimized.
Is a demerger good for stock price?
The stock price of a company generally drops immediately after a demerger. However, stock in the subsidiary can sometimes make up the shortfall. In the long run, demergers tend to have a positive impact on stock price, as a result of the businesses being more strategically focussed with independent management accountability.
