Growth Strategies

Fallen Branches

When subsidiaries fail on their own, how do you bring them back into the fold?
Magazine Contributor
4 min read

This story appears in the November 2001 issue of Entrepreneurs Start-Ups magazine. Subscribe »

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 but cancelled the move in March after the subsidiary's losses mounted and investors fled Internet stocks.

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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