Big tech companies currently have several good reasons to spin off portions of their businesses into standalone public entities. Unlocking hidden shareholder value, reducing operational inefficiencies, and securing a readily available market of investors comprised of their own existing shareholders — all are good arguments for tech firms to consider spin-off transactions.
But with rapidly advancing AI technology combined with hard scrutiny from government regulators, one of the best reasons for tech giants to consider spin-offs is to remain competitive and nimble in ways that larger organizations simply cannot.
Separating a company into multiple standalone publicly listed entities is among the most complex of transactions to execute. Despite that, when conditions are right, spin-offs can help companies add tremendous value and remain competitive internationally.
This article explores the use of spin-offs in recent decades, why time may now be ripe for a wave of these transactions, and how through spins tech companies can prepare for new opportunities for success.
What is a spin-off?
A spin-off is a separation transaction that results in the creation of one or more separate, publicly traded companies. Spins are popular when stakeholders believe that significant value will be unlocked through a standalone entity as compared to a single combined entity.
In a spin, instead of selling a business division to a third party, a public company “sells” a business line or lines to its own stockholders through a public listing of the carved out business and corresponding distribution of shares to the parent’s shareholders.
History shows an ebb and flow of acquisitions followed by spin-offs.
In the 1960s, due to a low interest rate environment, the United States experienced a sharp increase in leveraged buyouts across many sectors and a rise in corporate conglomerates as companies sought diversified operations to protect against economic downturns. But as interest rates rose, there was a decline in profits and a slowing of leveraged buyout activity. Equity markets began pricing in the operational inefficiencies of highly diversified companies. The resulting shift to focus on core competencies led to the first true wave of spin-offs in the 1980s.
Subsequent spin waves occurred in the early 2000s with large acquirers during the dot com boom reversing course as economic tides shifted and in the 2010s with tech companies citing the need to meet technology changes such as cloud computing and the internet of things. Spin-offs separated slower moving corporate giants from divisions that needed to more nimbly meet changes under less bloated cost structures.
Why a wave of spin-offs for Big Tech?
The top players in the US public tech sector are now some of the most valuable companies in the history of the world. According to the Boston Consulting Group, as of December 2021, the four largest technology companies accounted for almost half of all technology industry market value since 2016, and more than 40% of the total market value of technology companies. “Tech Comes Out on Top. Can It Stay There?, opens new tab” BCG, March 10, 2022.
In 2023, these four companies accounted for approximately 16% of the Fortune 500’s total profits (“4 tech giants accounted for more than 16% of Fortune 500 profits — even in a down year, opens new tab,” Fortune, June 6, 2023) and 84% of the Nasdaq 100’s $4 trillion market valuation growth. “The ‘Magnificent 7’ tech stocks drive markets higher as AI mania grips investors,, opens new tab” yahoo!finance, May 30, 2023.
As of 2024, the combined market cap of the seven largest US tech companies would make them the second-largest country stock exchange in the world. “Magnificent 7 profits now exceed almost every country in the world. Should we be worried?, opens new tab” CNBC, Feb. 19, 2024.
However, with increasing regulatory headwinds and booming market valuations for artificial intelligence businesses, spins may offer a way to unlock hidden shareholder value and divest operational inefficiencies.
a. Regulatory headwinds:
It has been said that data is the new black gold. Many companies in the U.S. technology space have utilized the growth by acquisition model to pivot into new industries, capitalize on new technologies and diversify their company portfolio offerings — often on the back of using or extracting this precious commodity which fuels the artificial intelligence revolution. Understandably, we have begun to see a large increase in tech companies investing to grow their data and AI-backed divisions.
However, a rise in antitrust dialogue within the technology landscape has led to major blockbuster acquisitions being challenged in court by U.S, and foreign antitrust regulators and, in some instances, forced divestitures of business divisions. Inorganic growth, a key driver over the last decade or so, is no longer a viable option for many large players in the industry due to their dominance across multiple industry sectors.
Spin-offs can offer a “fix it first” type remedy to such regulatory scrutiny by breaking up businesses.
The United States’ first major merger wave, which began in the late 1800s, resulted in the creation of industrial titans such as Standard Oil and U.S. Steel. These companies were broken apart in the early 1900s by antitrust laws. It seems like monthly one hears of a new regulatory challenge to the tech behemoths. The question is now how the tech giants of today will respond to being in the global regulatory cross hairs?
b. Unlocking value:
It is no secret that Wall Street prefers simplicity and human beings generally prefer the same.
From this premise follows the idea that when you have a conglomerate with tens or hundreds of small divisions or business lines, the market oftentimes undervalues the smaller segments. A “conglomerate discount” is the term used to describe the tendency of markets to value a company with a diversified group of businesses at less than the sum of its parts. This discount typically increases in proportion to the size of the conglomerate.
Value may become hidden or lost within a large conglomerate and a spin-off provides a viable option for increasing visibility and unlocking additional shareholder return. Increased equity research visibility as a result of a spin can unlock hidden value derived from a range of factors, including: (i) differential valuation multipliers for business lines, (ii) disparate growth rate models across the segments (e.g., blue chip v. high-growth) and (iii) distinct pools of investor bases (e.g., tech v. hardware or AI v. SaaS).
If stock prices are trading low, as we have seen with recent market declines, activists are better able to target larger companies — meaning an increased risk of spin campaigns for larger technology companies (particularly those with business divisions that are darlings of the market such as artificial intelligence).
If a company is able to unlock hidden value of a high revenue growth division, such as an AI or data security business, it can allow for short-term recapture of value during market declines and increased shareholder returns once the market enters into an expansion period.
c. Focus on core business:
A spin-off is compelling from an operational perspective as it allows for greater management team flexibility and increased, segmented focus on overall business efficiency.
•Oftentimes, organizational lines are not optimized across divisions. When businesses are separated, it allows leaders to individually tailor their organizational structures as is most efficient.
•Incentives amongst employees could also be revamped and refocused consistent with business goals to more directly motivate employees and achieve objectives.
•Spins can also ensure that business lines do not need to compromise through shared resources — albeit at the loss of benefits of scale.
•In some cases, the spinco entity may actually have become ancillary to the parent’s business and a separation allows for increased managerial focus, unlocking hidden value and optimizing for efficiency. This is a model consistently seen to drive returns in the private equity world.
Conclusion
It is critical that the U.S. tech sector — the lynchpin of the U.S. competition internationally — surmount today’s market challenges. As we enter the era of artificial intelligence, the United States needs its tech giants to maintain their competitive edge — even as they face regulatory challenges. A spin cycle could provide these tech companies with a fresh start to develop, expand and capitalize on new market opportunities and remain competitive within the AI field.
It is recognized that separating a company into multiple stand-alone publicly listed entities requires disentangling business lines and setting up a new operating company, all combined with a capital market transaction (and, in certain instances, a third party M&A transaction as well). Years of planning can take place prior to the execution of a spin, which typically takes anywhere from six to 12 months from announcement to close.
But when the market for private sales to third party buyers is weak, interest rates needed for M&A debt financing are high and equity is volatile, a spin-off, with its readily available market for the spun off company’s stock (i.e., existing stockholders), provides execution certainty for a transaction that can unlock value and increase shareholders returns.