Do Breakups Unlock Shareholder Value?

Call it the modern business equivalent of the myth of Sisyphus.

Having spent billions of dollars building up its business under Chairman Michael Armstrong, AT&T now plans to pare the business down to four separate companies under the AT&T name. On top of that, the company said its board voted to spin off Liberty Media Group.

This is not the company’s first reorganization. An antitrust settlement with the government in 1984 caused the company’s breakup into the seven regional Baby Bells, and a further voluntary break up in 1996 created Lucent Technologies and NCR.

AT&T is not alone. Recently, Lucent spun off corporate telecommunications company Avaya, business information company Dun & Bradstreet divided itself into an operating company and the debt ratings agency Moody’s, and 3Com Corp spun off its Palm Inc. division in March.

Corporate breakups, including spin-offs (when a subsidiary is spun off from its parent), equity carve-outs (full or partial public offerings) and the issuing of tracking stocks, are all the rage on Wall Street. So far this year, 110 deals have been announced, with about 60 completed, making for another record year. In 1999, there were 71 announced spinoffs with 66 companies following through.

Unlocking Shareholder Value

The deals are typically touted as meant to “unlock shareholder value,” but are they any good for shareholders?

Generally, yes, believes Mark Minichello, a principal at Spin-Off Advisors LLC, an investment research boutique in Chicago. Minichello says these deals are good news for both parent companies and investors, and the proof is in the market returns.

Investor pressure is driving these breakups, explains Jeff Stewart, chairman of the corporate law department at Arnall Golden Gregory LLP in Atlanta. Until very recently the belief was that big companies held a bigger the share of the market, and could spread costs and increase profits, he says. But the tide is now turning, and the trend today is for nimbler, more focused businesses.

“There are cycles and seasons, and there are periods of consolidation in industries and businesses,” Stewart notes. Today, the fashion on Wall Street seems to be for valuing the parts of a company more than the whole and the hope is that when taken as a whole the separate companies will be worth more than if they were under one umbrella, he adds.

Through the third quarter of 2000, corporate breakups completed in 1999 have since handily beaten the S&P 500’s return, generating an increase in market value of 106 percent for spin-offs, 71 percent for tracking stocks, and 68 percent for carve-outs, according to data from Spin-Off Advisors.

VoiceStream Wireless, which was spun off from Western Wireless Corporation in May 1999, posted the largest spin-off gain by increasing over 400 percent.

Pitfalls for Investors

But investing in restructuring companies can be tricky, and so it is worth doing some advance planning before investing in a deal, warns Minichello. There are many diamonds in the rough, he says, and investors must do their homework in order to find them.

Worth examining are the dynamics of the company’s industry, and the level of competition in the industry, he adds. “For example, the upcoming MCI tracking stock issued by WorldCom is one to avoid,” says Minichello. “Growth rates are declining in that industry ad margins are falling — that’s a bad sign. WorldCom itself still has potential, but you’ll need to think hard about the tracking portion.”

As a rule, corporate breakups are designed to unlock the value of core companies and subsidiaries. But without fundamental change, breaking up a bad company only produces more bad companies, argues Adrian Slywotzky, vice president at Mercer Management Consulting, a corporate strategy firm in Boston. “When there is a breakup investors should ask if anyone is fixing the business model, and if not there won’t necessarily be any shareholder value,” he says.

Indeed, breakups can unleash problems for investors, advises Stephen Barnes, a portfolio manager at Barnes Investment Advisory in Phoenix. Each shareholder trades their original shares for a share in each of the new companies; the general idea is that the value of the divided companies is more than their combined entity.

Up-and-Comer or Also-ran?

But investors should also look at how the company will be financed and examine the pedigree of the new management team, adds Barnes. “Don’t just look at the new company’s market valuation. Look at what its market position will be and its opportunity in that market — will it be an up-and-comer or an also-ran?”

Like AT&T, which will now break up into a consumer telephone business, represented by a tracking stock, and independent stocks representing the company’s wireless and broadband cable divisions, other companies have been busy dividing.

“The notion peddled by investment banks has been that size is the cure for every problem but it actually makes things worse in most cases,” says James Brock, a professor of economics at Miami University in Ohio. “My take is that the virtues of megamergers and gigantism have been oversold and suddenly people are beginning to say this in invalid and it doesn’t work and the emperor has no clothes.”

Indeed, the rash of restructuring is designed to please Wall Street and investors and help companies’ ailing stock prices, says Jeffrey Kagan, a telecom analyst at Kagan Telecom Associates in Atlanta. AT&T’s stock has dropped from just under $50 in early May to its recent price of just above $20. Similarly, WorldCom recently warned of a weakening business, and said that it also plans to restructure its business as a result. These companies are doing exactly what investors have been asking for, says Kagan: “It’s the tail wagging the dog.”

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