The Benefits of Demergers & Divestments

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.