By Dawn Cowie
Keeping shareholders happy in a falling equity market is a tall order but Suez SA has picked an increasingly popular answer in Europe: a spinoff.
Last week it said it will distribute 65% of the capital of its water and waste unit Suez Environment to its shareholders. In doing so, the French utility avoids the turbulence of the market for initial public offerings and the uncertainty of a trade sale. Assuming the merger of Suez and state-owned rival Gaz de France is approved by shareholders July 16, the Suez Environment will list on Euronext Paris and Brussels the following week.
"Spinoffs are coming back into vogue," said James Hartop , managing director in investment banking at UBS. "Companies have fewer tools in their toolboxes to create value in the current market but this is one way they transfer cash directly into the hands of shareholders."
Morgan Stanley research this month highlights a few important potential spinoffs. Security services company Securitas /zigman2/quotes/203151739/delayed SE:SECU.B +0.61% has announced the spinoff of Loomis, a cash-transportation unit. Energy group BP /zigman2/quotes/207305210/composite BP +1.48% PLC is considering the partial sale or IPO of its renewable-energy portfolio.
Meanwhile, Spanish oil-and-gas company Repsol YPF SA has said it is looking to float about 20% of its Argentinian business YPF in the second half of this year.
There are two main reasons spinoffs generate value. First, the market often recognizes greater value in a subsidiary when it is separated from its parent, which is what Suez said it expects from its spinoff. Second, the management of a demerged entity may have more freedom and a strong incentive to improve performance.
The preparation and marketing for a demerger or spinoff is similar to that involved in an IPO. The fees earned by investment banks, however, tend to be lower for spinoffs because they aren't using their distribution channels for raising money.
To be sure, a demerger has a few complications of its own. No price is set ahead of trading -- Suez shareholders will get 0.25 shares in Suez Environment for every Suez share they own -- so the stock has to find its own level. Whereas an IPO has only buyers, spinoffs also involve a multitude of sellers.
"This can create a complicated dynamic in the aftermarket," said Mr. Hartop. This makes it difficult for companies to get a clear sense of a spinoff's market value.
But in today's volatile market, it is hard to gauge the right price for IPOs, anyway. For instance, shares in Iberdrola Renovables SA, a wind-energy unit of Spanish Iberdrola SA, last week were trading 14% below their offer price after its much-hyped flotation in November.
Some recent research supports the idea that spinoffs deliver value. Analysis by Morgan Stanley of the performance of 33 stocks that were spun off from their parent company from 2000 to the end of 2006 showed that both the divested entity and its parent outperformed the MSCI Europe index.
Ronan Carr, European equity strategist at Morgan Stanley, found no pattern to suggest that asset sales perform better if they are done early in the economic cycle, so the current downturn shouldn't be a deterrent.
One success story has been the demerger of chemical company Lanxess AG from its German parent Bayer AG in 2005. It is an example of where independence gave management a strong incentive to improve performance.
At the end of its first year, Lanxess said it had cut net debt by 40%. The company outperformed the MSCI Europe stock index by 89% in two years, while Bayer also outperformed the market by 33%.
However, the downside to a spinoff is that if a parent company needs to raise cash, a spinoff doesn't provide it. So instead, some companies choose to spin off their assets by selling them to other corporations.
Morgan Stanley research shows there are at least 25 European companies with assets up for sale, including Royal Bank of Scotland Group PLC's insurance arm and Allianz /zigman2/quotes/218302426/composite AZ -8.72% SE's investment-banking business Dresdner Kleinwort. However, such assets are hard to sell in the current market. Private-equity buyers are struggling to access the leveraged finance market to mount bids.
Also, a demerger has clearer benefits for shareholders than an asset sale. With a sale of assets, the parent company decides what its assets are worth and what it does with the money raised. By contrast, with a demerger, the market sets the price and shareholders choose what to do with the proceeds.
From Financial News at www.efinancialnews.com