When a spinoff is on the board's agenda.

• Author: Carey, Dennis C.

Directors have distinctive strategic and board composition decisions to make when involved with a spinoff

The mid-1990s have witnessed a new surge in corporate restructurings. Of those restructurings, only spinoffs allow the affected business unit to create its own board of directors and place all of its stock in the public marketplace. Never before in corporate history have so many new spinoff companies been created. All are justified in the name of "enhancing shareholder value." Others have additional justifications, ranging from dealing with emerging strategic business conflicts such as the case at AT&T, Electronic Data Systems, and Baxter International, changing the "mix" of shareholders such as at Dun and Bradstreet, to (although not publicized as such) reversing failed acquisitions made during the 1970s and '80s. Spinoffs have become for some companies a vehicle to refocus and renew the entire corporation.

According to J.P. Morgan & Co., a close tracker of spinoff activity and a leading adviser on spinoff transactions, 41 spinoffs were completed in 1996, with a total value of $94 billion. Twenty of those spinoffs each had a value over $500 million, a marked indication of the sizable nature of this activity. This dollar volume of 1996 spinoffs is up dramatically from 1995 (itself a record year), when some 33 spinoffs with a value of $51 billion were completed.

In its fundamentals, a spinoff is set up as a standalone business with ownership given to the parent's existing shareholders through a distribution of common stock in the new business. The typical spinoff is designed to be a tax-free transaction for the shareholders, since they already own the business through their ownership of the parent company's stock.

Market outperformers

Spinoffs are not a new phenomenon. The literature contains references to the performance of spinoff companies dating back to 1965. The data show $11 billion in spinoff activity in 1988, a level from which spinoffs declined precipitously into the early 1990s (along with other forms of dealmaking) and not surpassed again until 1993, when the current record-setting pace began in earnest.

Why the sudden surge? In part, the activity is fueling itself, based on data suggesting that these transactions actually do increase value. J.P. Morgan's tracking finds that spinoff companies are outperforming the market by an average of 20% in the first 18 months of independent operations. The parent company's stock also outperforms (as well it should according to valuation theory), and the greatest response comes from spinoffs of large and profitable operations, the kind done by ITT (with ITT Industries and ITT Hartford), General Motors (with EDS), Sprint (with 360 Communications), 3M (with Imation), and other major players. Most spinoff companies tend to have higher growth rates, operating income, and capital...