17 - Divesting Rather Than Investing...Why Oil & Gas Companies Spin-Off

Today’s evolving Oil market is governed by stringent regulations, new technologies, and volatile commodity price. To remain competitive, Oil & Gas companies need to continuously position themselves in the marketplace. While some companies decide to invest in Mergers & Acquisitions (M&A) or in revamping their corporate infrastructure; other companies decide to divest by spinning off some of their business.

What is a Spin-off

A Spin-off is a type of divestiture, where a company creates an independent legal entity (or several) through the partial disposition of its business. Such transaction is concluded by:

• sale, or

• distribution of new shares.

A simple way of portraying a spin-off is by considering it as the opposite of a Merger & Acquisition, where part of the business is being demergered from the parent company.

Why Companies Spin-off

The general rule is that management decides to spin-off a business because they presume that both entities (the parent company and the spun-off business) will perform better independently.

There are several other drivers for a spin-off:

• The parent company needs cash to fund a new venture

• The spun-off business is not part of a core competency that the parent company wish to keep (e.g. Schlumberger spinning off Sedco-Forex Offshore in 1999)

• The parent company grew too large till it realized diseconomies of scale

• The spun-off business became redundant due to a previous Mergers & Acquisitions transaction.

• The spun-off business is considered low-growth, therefore affecting the parent company financial performance

• The parent company wants to realize the full potential of its business by spinning off some divisions

• The spun-off business is operating in a jurisdiction that requires special handling due to political, legal, fiscal or cultural consideration.

• The parent company is not able to sell its business as a whole, so a spin-off sale is a reasonable compromise

• The parent company receives a court decision to spin-off (e.g. the U.S.A. Supreme Court ordered the dissolution of Standard Oil to 34 Companies in 1911)

What Is The Upside Of A Spin-Off?

Usually, spin-offs perform better because the new structure allows both entities to focus on their specific product(s) or service(s). Below are some of the many spin-off benefits:

• Shares of the new company are distributed tax-free to shareholders of the parent company

• The parent company avoids transaction costs associated with the sale

• Historically speaking, by spinning-off, the sum of the two stocks value surpasses the consolidated stock value within a short period

• As a smaller company, the spun-off business has higher potential to grow.

Any Downside For Spinning-Off A Business?

The downside of spin-off links mostly to the skepticism surrounding the growth potential of the new business structure, and whether the spun-off business will be able to grow away from the parent company. Below we demonstrate some of the spin-off downside with respect to each entity:

Spun-off business

• share price drops due to high selling volume, as shareholders don't want to keep the spun-off business in their portfolio

• share price volatility, as the market responds to the spin-off with mixed feelings

• New business name which requires marketing and branding spendings

• Turnover, as employees don't wish to associate themselves to the smaller entity

Parent Company

• Book value drops as some assets are transferred to the spun-off business

• Immediate drop in share price due to the redistribution of assets

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