It's not hard to see why companies spin off units. Last
year, while the Dow Jones Industrial Average lost more than 6
percent, telecommunications firm Comverse Technologies spun off its
Ulticom Inc. software subsidiary for more than $200 million. IPO
investors racked up returns exceeding 60 percent for the year.
Spinoffs can be excellent tools to tap value latent in a
subsidiary or business unit, according to J. Randall Woolridge,
finance professor at Pennsylvania State University in University
Park and co-author of Spin-Offs and Equity Carve-Outs
(Financial Executives) with Penn State colleague James Miles. They
can also help the units grow faster and improve profitability.
But not all companies are so lucky. As spinoff mania crossed
paths with the dotcom frenzy, many companies tried and failed to
spin off online subsidiaries. Office supply retailer Staples Inc.,
for example, planned to spin off Staples.com but cancelled the move
in March after the subsidiary's losses mounted and investors
fled Internet stocks.
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And that's where companies often run into difficulties.
Staples found itself surrounded by controversy when it offered to
buy executives' stakes in its failed spinoff at rich
valuations. And it's not alone: Experts say trying to merge a
failed spinoff back into the parent company will always cause
problems.
Picking Up the Pieces
Reintegration issues range from resettling workers to dealing
with obligations assumed by the spinoff, according to Lawrence
Baye, a principal in the New York City office of accounting firm
Grant Thornton LLC. "It's about more than what the pro
forma financial statements are going to look like when you
recombine these two things," he says.
People issues are likely to loom large in any reintegration of a
failed spinoff. Often, you won't be able to continue to employ
everyone at the spinoff in the new, merged organization, Baye
warns. Those who remain may need to be reassigned or retrained so
their skills match their new jobs. For instance, a manager who was
responsible for an entire department in the spinoff may now be just
an assistant in the merged enterprises. That manager will need to
become used to being subordinate.
Customers and suppliers must also be alerted to the
reintegration and have their concerns addressed. You may have
problems, for instance, if the spinoff was getting different terms
from suppliers than the parent organization does from the same
suppliers. Also, customers regarded as large and important at the
spinoff may be viewed as minor-league players in the merged
enterprises. Communicating the change and, if necessary, smoothing
ruffled feathers are essential tasks after reintegrating a
spinoff.
Technology is another consideration. Baye was involved in the
reintegration of one spinoff that had begun using a software
package that was incompatible with what the parent company used. If
the subsidiary wanted to keep using the software, the parent
company had to pay a hefty ongoing licensing fee to the
software-maker. Instead, it spent several months and a large sum
converting the former spinoff's data to a compatible
format.
In addition to licensing fees, you may find yourself responsible
for leases, loans, employment contracts and other spinoff
obligations, Baye adds. "Sometimes the parent buys them back
and finds out they're committed for the next 10 years to rent
out the Queen Elizabeth for a convention," he says. Even
government regulators may get involved if, for instance, the parent
finds it is now in a business for which the spinoff was licensed
but it is not.
Finally, look closely at the books. A struggling spinoff may not
be recording sales or write-downs in as conservative a manner as
your corporate standards call for, Baye warns.
Potential problems don't necessarily make spinoffs a bad
idea. Even unsuccessful ones can yield healthy fruit, says
Alexandra Reed Lajoux, author of The Art of M&A Integration: A Guide to
Merging Resources, Processes and Responsibilities
(McGraw-Hill). "Uprooting plants and repotting them can make
them stronger," says Lajoux. "If you spin something off
and you need to reintegrate it, the roots can grow
stronger."
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