17 - Divesting Rather Than Investing...Why Oil & Gas Companies Spin-Off
Updated: Aug 29, 2018
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:
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:
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
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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