Understanding Spinouts Their Drawbacks Examples

Understanding Spinouts, Their Drawbacks, Examples

What Is a Spinout?

A spinout is a type of corporate realignment involving the separation of a division to form a new independent corporation. The spinout company takes the operations of the segment and associated assets and liabilities.

The parent company is required by the Securities and Exchange Commission (SEC) to detail the spin out in Form 10-12B, which contains a substantial information letter or narrative that outlines the rationale for the spinout, strengths and weaknesses of the new company, and the outlook of its industry. A spinout, which is typically tax-free to shareholders, can take up to six months to complete.

Key Takeaways

– A spinout is a type of corporate realignment involving the separation of a division to form a new independent corporation.

– The spinout company takes the operations of the segment and associated assets and liabilities.

– A spinout allows the division to raise its own capital through issuing stock and operate its own business strategy.

Understanding Spin Outs

Spinouts can occur for various reasons. The parent company might want to unlock the value of the embedded division, which might be growing at a different pace than the overall company. Usually, a trapped or constrained segment that’s growing faster than its parent would be better off as an independent company.

A spinout allows the division being spun off to raise its own capital through issuing equity shares or debt to fund the company’s growth. The financing might not be possible with the combined entity, but by separating out the profitable division, the spun-off division has a greater chance of attracting investors and banks.

Spinouts can also help the parent company by allowing it to focus on its core operations without diverting resources to a segment that could have different needs including operations management, marketing, finance, and human resources.

Additionally, the division being spun out could have been established to create an ancillary service such as software or technology. While profitable, the technology division might not fit in with the industry of the parent company. It might be better to split them since the business plans and strategies might not align with each other.

Although spinouts are typically a positive sign for a company, investors might not like what remains at the parent company after the spinout and sell its stock.

A spinout could also occur if the division is not as profitable as the parent company. By creating a separate company, it removes the distraction of the struggling division. Also, a spinout could allow the management to sell off assets or look for a merger or buyout of the new company.

Parent companies often provide support for their spinouts by retaining equity in them or signing contractual relationships for the supply of products or services. In many cases, the management team of the spun-out firm is drawn from the parent company as well.

Some Drawbacks of a Spinout

Investors are generally in favor of a spinout, as it makes business sense for a segment that has different needs and growth prospects to go it alone. The sum of the separated parts is usually greater than the whole for investors, as valuations over time have demonstrated.

However, the spinout process can be costly in terms of management time and distraction for a number of months. Management’s focus may shift from running the company to executing the spinout. Also, there can be significant transaction expenses to plan and complete a spinout.

Of course, there’s no guarantee the spun-out division will be profitable by itself. A spun-out company could incur losses or poor earnings without the help of the parent. Conversely, removing a profitable division through spinning out might leave the parent company with less revenue and vulnerable to poor financial performance.

Examples of Spin Outs

Spinouts are common, and investors have good reason to push for them. There are many notable spinouts including Mead Johnson Nutrition, spun out of Bristol Myers Squibb in 2009, Zoetis spun out of Pfizer in 2013, and Ferrari spun out of Fiat Chrysler in 2016.

Delphi Technologies PLC

Delphi Automotive spun out Delphi Technologies PLC, a $4.5 billion entity on December 5, 2017. The new company offers advanced propulsion systems enabled by increases in computing power and smart vehicle architecture.

Delphi Automotive became Aptiv PLC and retained the powertrain business. The spun-out Delphi Technologies PLC is in charge of its own destiny.

A Failed Spin Out: Old Navy

Clothing retailer Gap Inc. announced in early 2019 its intention to spin out the division of Old Navy. Old Navy will be an independent company. The Gap stores, including other brands such as Banana Republic, Hill City, and Athleta, will be one company.

In 2018, Old Navy generated nearly as much revenue as all the other brands combined with its $8 billion in sales versus $9 billion in revenue from the Gap and the remaining stores. As a result of the possible spinout, Old Navy would have been freed up to grow its brand under its own business plan and strategy. The Gap and the remaining stores would consolidate since their sales have struggled to grow over the last few years.

However, this spinout never came to pass. In 2020, Gap decided to retain Old Navy, as the viability of the company’s standalone prospects diminished amidst low-cost competition from big-box retailers. After making that announcement, Gap shares spiked higher.