Transformational Investor Relations in Spin-Offs, Split-Outs and Rationalizations

Corporate restructuring is a non-recurring exercise that can have a lasting impact on the corporations involved.

Restructuring comes in many different forms, including but not limited to spin-off transactions and corporate rationalizations. Some are massive undertakings involving thousands of employees and entire corporate divisions, which lead to analyst re-ratings and fundamental changes in the shareholder base. Some are modest downsizings. Either way, investor relations practitioners are central players who are required to take on various responsibilities, not the least of which is communicating restructuring rationales to shareholders.

In this issue of IR focus, we examine what could be called transformational investor relations with a view to providing relevant and meaningful insight on one of the most common types of restructuring – rationalizations – and on the more complex issues involved in spin-offs and split-offs. The timing of this article is significant. A recent report from Torys LLP predicted that we should expect to see “more businesses undertaking spinoff transactions and divestitures in 2022 as a way to return value to shareholders and refocus their strategic direction.”

Spin-Offs, Split-Offs and Other Forms of Restructuring

In common vernacular, spin-offs, split-offs and split ups are used interchangeably. They are not the same, however, although the end game of increasing shareholder value is.

Spin-offs are used to separate a division or line of business from its parent company. In a traditional spin-off, the parent company forms a subsidiary corporation (if the line of business or division is not already a subsidiary). The parent company transfers the relevant assets to the subsidiary and the subsidiary assumes the corresponding liabilities. The parent company then declares a dividend of the equity shares of the subsidiary to the shareholders of the parent company. In a full spin-off, the parent company retains zero ongoing interest. In a partial spin-off, the parent holds a minority interest in the subsidiary.

Split-offs, on the other hand, involve an exchange offer in which the shareholders of the parent company exchange their stock in the parent for stock in the new entity.

Yet another way to restructure is a subsidiary offering, whereby the parent makes a public offering of its subsidiary’s stock. There are also split-ups, which end when the parent company dissolves itself after distributing the stock of its subsidiaries to its shareholders. If that isn’t enough, there is also an approach whereby a parent company creates an additional class of shares intended to track the performance of a subsidiary. A so-called tracking stock can then be distributed in whichever way a parent chooses – to its existing shareholders or to the public.

The type of structure/approach used depends on several factors including primarily tax considerations, as well as securities regulations, corporate dividend laws and commercial and industry factors.

Common Spin-Off Rationales

Regardless of the form they take, spin-offs, split-offs and split-ups are transformative. From a rationale perspective, primary advantages normally associated with these types of restructurings include the potential to unlock trapped or hidden shareholder value in the parent company, the opportunity to deleverage the parent company’s balance sheet and/or improve access to credit or equity financing for a growth business and the chance to improve corporate governance and management focus by creating two companies (each with its own Board, executive leadership and capital allocation strategies).

Take the fictional example of Acme Corp: it has a widget division that is not synergistic with the rest of its business as it operates in an entirely different industry. Acme Corp’s Board decides that Acme Widgets has the scale to stand on its own and no longer fits in the corporate structure/plan for the future. Accordingly, it weighs the merits of doing a spin-off, including the value of achieving a simplified corporate structure with a pure play business focus. In its analysis, the Board notes that typical widget businesses trade at 10x EBITDA, while pure play non-widget businesses trade at 15x EBITDA. By separating HoldCo from SpinCo, HoldCo’s Board believes equity in Acme Corp. will be valued at a higher multiple and, over the long term, keep that higher multiple by redeploying capital previously required for widget manufacturing into its higher earnings, higher growth non-widget business.

Let’s take this storybook example to its fictional conclusion. Before the spin-off, Acme Corp attracted a 10x multiple; following the transaction, Acme Corp’s multiple climbed to 14x, and Acme Widget began trading at a widget industry average 10x. In this scenario, the shareholders of Acme Corp win immediately, while Acme Widget’s task over time is to attract a higher multiple than its industry’s average.

Herein lies another advantage of spin-offs to both HoldCo and SpinCo: each is now free to pursue its own distinct capital allocation strategies, unencumbered by competing business priorities. Theoretically, this would result in better standalone performance for both entities. Furthermore, investors would be better able to evaluate the results and potential of HoldCo and SpinCo, resulting (potentially) in a more favourable cost of capital for each.

The Role(s) of IROs in Spin-Offs/Split Outs

Where are the services of the IR team required in a spin-off/split out? The answer to that question is from beginning to end. These forms of restructuring require advanced planning by HoldCo across multiple disciplines, including investor relations, tax, legal, investment banking, corporate secretarial, treasury, supply chain and human resources – each with its own (often overlapping) work streams.

As a starting point, it is widely acknowledged during such restructurings that IROs will be expected to keep their management teams and Boards informed of investor sentiment regarding all aspects of a business, including subsidiaries that are the subject of a potential spin-off. This insight will enhance management’s understanding of the level of shareholder support that might be garnered by doing a spin-off transaction of a specific business division, or asset group. An asset group could include real estate owned by a company spun off into a REIT. This real estate spin-off strategy has been toyed with by organizations such as Tim Hortons Inc., which decided in 2013 not to pursue it, and executed by companies such Loblaw Companies Limited, which spun off its interest in Choice Properties Real Estate Investment Trust in 2018.

With a detailed understanding of all the industries in which their companies compete, and trading multiples therein, IROs are often among the first proponents of spin-offs.

IRO-driven market intelligence will also provide early signals to management teams/Boards of possible shareholder actions to force a spin-off or divestiture. Such shareholder advocacy is common and IROs are expected to help formulate a sound rationale for and against a restructuring, depending on the Board’s determinations. In the previously noted example of Tim Hortons, then CFO Cynthia Devine (who has graciously spoken at CIRI events in the past), told company investors that a REIT structure would not create significant value “for a number of reasons…(including) the number of leases in our system and the fact that there is a portfolio of income we derive from real estate which may not be considered qualifying income for REIT purposes.”

Taxation and Spin-Offs/Spin-Outs

Taxation is a major consideration in spin-offs, and an area in which IROs require insight. There is a large, albeit complicated, body of knowledge about the common forms that spin-offs can take, including:

A butterfly transaction, which is permitted by the Canada Revenue Agency in certain circumstances to facilitate the formal transfer of ownership in a corporate property without immediate tax consequences;
A return of capital transaction, whereby HoldCo reduces the stated capital of its common shares by an amount equal to the fair market value of SpinCo common shares and distributes SpinCo shares on a pro-rata basis to HoldCo shareholders; and
A share capital reorganization, whereby HoldCo shareholders exchange all their existing HoldCo common shares for a combination of a new class of HoldCo shares and SpinCo shares.

It is not the role of IR focus to delve deeply into the topic of taxation. Suffice it to say spin-off structures carry the risk of triggering tax liabilities. If not handled properly, such liabilities significantly reduce the value of this form of restructuring. In announcing its restructuring transaction in 2018, Loblaw very clearly noted that if it were to “hypothetically spin out or directly distribute its interest in Choice Properties to Loblaw's shareholders, it would trigger approximately $640 million of tax payable by Loblaw, which is equivalent to approximately $1.70 per Loblaw share.” Instead, Loblaw created a spin-off structure enabling the transaction to occur on a tax-free basis.

Like Giving Birth Using a Team of Expert First Responders

Assuming a company’s Board is supportive of a spin-off, IROs can expect to be intimately involved in advance planning meetings. One IRO described this process as like “giving birth” to an entirely new entity. This characterization reflects the fact that, in this practitioner’s mind, “a spin out is a form of an IPO just not necessarily with a tag-along capital raise.”

IR team responsibilities prior to a spin-off can include developing deal presentations for investors in collaboration with investment bankers and lawyers, as well as the planning of arrangement news releases and briefing documents for Boards/management teams on market perception. Coaching CEOs and CFOs to prepare to articulate the spin-off rationale and advantages is also within the remit of IROs. Although large subsidiaries may be subject to segmented reporting before a spin-off, invariably there will be a new level of financial disclosure to manage as the subsidiary is readied for prime time.

In a spin-off, the insights and experiences of I-bankers and lawyers are of immense value. However, IROs should feel confident in bringing their own perspectives to bear and ensuring that HoldCo’s interests and ways of communicating with shareholders are recognized and respected.

The Boards of SpinCos are not normally constituted until the spin-off occurs, but it is common for HoldCos to name both the Chair and CEO of SpinCos at the time the restructuring is announced. There are strategic and practical reasons for this. The strategic reasons include the need for SpinCo to adopt (and be seen employing) best governance practices from day one. The practical reason is that there is no honeymoon for SpinCos from activist investors who may pounce within days of stock exchange trading. Strong, independent and experienced governance is a must. While SpinCo will inherit transition agreements from HoldCo, SpinCo will need to adopt a public company charter and by-laws, implement corporate governance policies including controls over financial reporting and create a highly capable IR function.

Those HoldCo executives – including IROs – who have been through the spin-off process warn that there is often tension between HoldCo and SpinCo as the latter looks to distance itself from the parent company. This tension needs to be well managed as it carries reputational risk.

Opportunities for IRO Career Development

The roles played by IROs in this governance/leadership transition are varied. Some members of HoldCo IR teams have been seconded to assist SpinCo’s executives in establishing investor and bondholder relations functions. Still others have served as IROs for SpinCos not just during a transitionary phase but on a permanent basis. Still other HoldCo IROs have been asked to help recruit IR teams for SpinCos. In all cases, there are opportunities for development and growth in an IRO’s career.

Before they ever happen, spin-off restructurings add significantly to an IR team’s workload. That workload will continue through the day-of announcement when a plan of arrangement is communicated, on to special shareholder meetings when necessary to approve the plan and for months following as HoldCo and SpinCo find their respective ways in the capital markets. New shareholders will need to be attracted to both entities, and both entities will need to communicate their own value creation strategies, competitive strengths, growth opportunities and risk management approaches independent of each other. Equity research coverage of SpinCo often does not happen immediately after the restructuring, as analysts must develop their own models. This is another challenge for the IR function, along with the fact that some large shareholders in HoldCo may sell their shares in SpinCo due to differences in status, size and industry.

In short, for both HoldCo and SpinCo IROs, this is transformational IR. For recent examples, see:

Daimler AG, which spun off its truck and bus division as a separate publicly traded company called Daimler Truck and renamed itself Mercedes-Benz Group AG – a restructuring that began in 2017 and concluded in 2021;
H&R REIT, which spun off its Primaris properties portfolio, including all enclosed malls, to a new standalone, publicly traded REIT called Primaris in December 2021;
Merck, which spun off its biosimilars and women’s health divisions into a new company called Organon & Co in 2021 after stating its intention to restructure in early 2020; and
Toshiba, which in early February 2022 announced its plan to restructure through the spin out of its semiconductor business – the first such spin-off by a large Japanese company.

For IROs interested in knowing more about the topic, reading the public disclosures of these businesses is enlightening.

The Role(s) of IROs During Rationalizations

From an investor relations perspective, rationalizations are the most straightforward types of restructurings, even though they can have an impact on corporate valuation and the shareholder base. Flipping the previously used example of Acme Corp, let’s say it elects to close an underperforming, non-core division. The division has made widgets for 50 years while the rest of the company does not make widgets. Acme’s IRO has spent years explaining to investors why widgets are a necessary part of the company’s shareholder value creation equation. The IRO knows many investors dislike the widget business and has told Acme’s senior management this repeatedly. However, a few investors bought into the company 10 years ago specifically because they liked widgets.

In this example, it is necessary for the IRO to do several things:

Prepare a briefing package for management/the Board, indicating how key investors and sell-side analysts may perceive the rationalization of Acme’s widget business, on the assumption that the event may trigger share buying or selling depending on individual stakeholder views. Such a briefing could make use of anecdotal information gleaned in previous discussions with stakeholders (including shareholder perception surveys).
Encourage/challenge management to disclose the full impact of the rationalization including estimated costs to close the division, payback from doing so, and expected loss of revenue. It is advisable to state restructuring costs in ranges when there is a risk of overspending the estimate. This can be the case when a company has European operations where downsizings are subject to negotiations with workers’ councils.
Develop disclosure information that starts with the rationale for the move and pinpoints the divisional assets that will close. Sometimes, the financial rationale is a veritable no-brainer (in the example above, who wants widgets in a non-widget world) but just as often, there are complicating factors. In situations when a company’s management has long defended the division, the IRO must be sensitive to a loss of corporate credibility. Credibility is also at stake if the costs to rationalize are greater than estimated and the payback is not achieved in the time frame management sets.
Consider how the information will be disclosed – is the rationalization material, or is it small, immaterial and worthy of a sentence or two in the quarterly MD&A? Materiality aside, it is necessary to be careful in making this judgment as rationalizations involve workers who, when downsized, have no compunction about sharing information with competitors, customers, the media or shareholders. The company has the upper hand in shaping perception in its broader communities, but only if management chooses to communicate when the decision to rationalize is taken. IROs we spoke to agreed: it is better to play offense than defense.
Create a key message document for management that addresses all likely shareholder and analyst questions. HR and PR teams must engage in the creation of this document, as they will have knowledge to share and stakeholder perceptions to shape/protect. Such documents could be considered table stakes for IROs in all forms of restructurings including rationalizations and spin offs.
Share all information and communications plans with your Board or relevant committee of the Board. Experienced corporate directors usually have their own personal involvements with restructurings and can be valuable advisors in these situations.

Corporate rationalizations happen all the time and when presented thoughtfully to the world, with a strong rationale, are often seen in a positive light by shareholders – unless your company rationalizes on a regular basis without being in turnaround mode.

In a turnaround, all the points above still apply, but there is an additional item to consider and that is strategic context. In such situations, it is advisable for management to communicate – in advance – a master plan for corporate action so that investors can see all rationalizations that follow as part of a strategy to put the company on solid footing. Rationalizations without context can easily lead to a loss of investor confidence.

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