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Nov. 13, 2021, 9:20 a.m. EST

Why GE’s tax-free split could power the stock higher and reward patient investors

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By Lawrence A. Cunningham

Shareholders should welcome the announcement that General Electric /zigman2/quotes/208495069/composite GE +2.29% will become three companies. Using a mechanism called a spinoff — a tax-free dividend to GE shareholders of new shares in the separated businesses — CEO Larry Culp pursues value creation modeled by corporate titans from John Malone to Bill Stiritz and by companies from ITT /zigman2/quotes/203522138/composite ITT +0.61% to Danaher /zigman2/quotes/210555154/composite DHR +1.18% , which Culp used to run.

At GE, Culp is addressing a problem common to large corporations: a centralized command structure over multiple divisions.  Such cultures offer limited incentives for creativity, adaptability and versatility.  Spinning off a company liberates it from that culture, enabling managers to be more focused on their individual business and setting them up for increased chance of success. 

One  practitioner of multiple spin-offs  is William Stiritz of Ralston Purina . When Stirtiz arrived at Ralston, the sprawling food products company famous for pet food, it had grown to include a variety of businesses, collectively called Ralcorp . They operated in many unrelated niche areas — infant formula, cereal, cookies, and ski resorts. Stiritz observed that such a wide array of business could not be managed efficiently and devised a plan to reorganize the company.

Stiritz embarked on a series of spinoffs, after which he saw a transformation in corporate leadership. Many Ralcorp managers who showed modest abilities beforehand became “incredible managers” when leading their own stand-alone businesses.  Stiritz calls the spin “the ultimate form of reorganization for better results.” Those results were so strong at Ralston that Stiritz earned a chapter in Will Thorndike’s masterpiece, “The Outsiders,” and was awarded  the Singleton Prize for capital allocation in 2019 .

Perhaps the best-known  practitioner of the corporate spinoff  is John Malone of Liberty Media /zigman2/quotes/206865773/composite LSXMA +1.13% . Throughout its history, Liberty Media has been a relentless acquirer of a wide variety of businesses extending far beyond its origins in communications. But rather than creating a conglomerate of diverse businesses, the company has also been a relentless divestor. Spinoffs have been a favorite tool of divesture, including such prominent companies as Liberty Global/Discovery , DirecTV , Expedia /zigman2/quotes/202291990/composite EXPE +3.15% , Liberty Global /zigman2/quotes/205000522/composite LBTYA -0.18% , Starz , and QVC. All of these businesses prospered after their spins.

By constantly divesting, Malone avoids the problems of corporate suffocation that Stiritz referred to. It is as if the king parcels out earldoms, dukedoms, and other fiefdoms and locates them where their value will be best nurtured, to grow into new kingdoms.

The only other way to do that is to maintain an autonomous and highly decentralized business model, most famously done by Warren Buffett at Berkshire Hathaway /zigman2/quotes/208872451/composite BRK.A -0.51% /zigman2/quotes/200060694/composite BRK.B -0.30% , and also by  such kindred companies  as Amphenol Corp. /zigman2/quotes/207999687/composite APH +1.72% , Carlisle Cos. /zigman2/quotes/206929371/composite CSL +1.87% , Dover Corp. /zigman2/quotes/208444467/composite DOV +3.14% , Illinois Tool Works /zigman2/quotes/208031922/composite ITW +1.49% , Markel Corp. /zigman2/quotes/207564531/composite MKL -0.56% and Roper Technologies /zigman2/quotes/204270015/composite ROP +1.68% . Yet maintaining such a culture while operating at scale is difficult — and many such decentralized companies have also made spinoffs, including Constellation Software /zigman2/quotes/203440310/delayed CA:CSU +0.95% (where I serve on the board), Graham Holdings /zigman2/quotes/206889364/composite GHC +1.09% , and Danaher Corp., Culp’s former company.    

That’s why the conglomerate diminished in popularity in the 1990s, often dismantled by spinoffs.  It was through spinoffs that ITT, for example, split into three in 1995, how AT&T /zigman2/quotes/203165245/composite T -0.93% divested Lucent and NCR in 1996, and how Alleghany Corporation — also highly decentralized — spun-off its Chicago Title Corporation business in 1998. 

Others have used spins as part of a recurring process that involves both regular business expansion — whether acquired or organic—and later divestitures of some of them. An example is Sears Holdings , which from 1993 to 2014 spun off such powerhouses it had nurtured as Allstate, Dean Witter, Diehard, Discover, and Land’s End . Given the eventual  fate of Sears as a retailer , it’s clear that those companies benefited from being spun out.

Such results explain why activist shareholders often prescribe spinoffs of excessively diversified businesses. In recent years prominent spins instigated by activist investors include eBay /zigman2/quotes/204653455/composite EBAY +1.82% spinning PayPal Holdings /zigman2/quotes/208054269/composite PYPL +1.74% (at the urging of Carl Icahn); EMC spinning VMware /zigman2/quotes/209864107/composite VMW +0.71% (Elliott Management); and Timken /zigman2/quotes/200714911/composite TKR +1.76% spinning TimkenSteel /zigman2/quotes/204754445/composite TMST +1.88% , its steel business (Relational Investors).

Spinoffs also promote accountability to shareholders. Business divisions become opaque inside large organizations, making it difficult for investors to understand and evaluate a company. Spinoffs correct this problem — useful whether or not the business performs well.

Spins have become increasingly common in recent years as a way to increase focus and related capital allocation, whether at conglomerates or otherwise. As such, a strategy that includes spinoffs as a regular element can be a strong general deterrent to activists, as well as a source of shareholder value.  Applying that strategy at an old conglomerate like GE is another reason shareholders will be listening closely to Larry Culp.  

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of “The Essays of Warren Buffett: Lessons for Corporate America.” Cunningham owns shares of Berkshire Hathaway, and Constellation Software. He is a director and vice-chairman of Constellation Software. For updates on Cunningham’s research about quality shareholders, sign up here

More: GE is splitting up. The pieces are worth more than Wall Street thinks .

Plus: Why increased capital spending is setting up this select group of industrial stocks to outperform in the next few years

/zigman2/quotes/208495069/composite
US : U.S.: NYSE
$ 82.32
+1.84 +2.29%
Volume: 7.25M
Feb. 1, 2023 4:00p
P/E Ratio
N/A
Dividend Yield
0.39%
Market Cap
$87.94 billion
Rev. per Employee
$455,685
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/zigman2/quotes/203522138/composite
US : U.S.: NYSE
$ 92.15
+0.56 +0.61%
Volume: 543,726
Feb. 1, 2023 4:00p
P/E Ratio
21.89
Dividend Yield
1.15%
Market Cap
$7.57 billion
Rev. per Employee
$292,778
loading...
/zigman2/quotes/210555154/composite
US : U.S.: NYSE
$ 267.50
+3.12 +1.18%
Volume: 3.62M
Feb. 1, 2023 4:03p
P/E Ratio
27.70
Dividend Yield
0.37%
Market Cap
$192.46 billion
Rev. per Employee
$393,388
loading...
/zigman2/quotes/206865773/composite
US : U.S.: Nasdaq
$ 41.08
+0.46 +1.13%
Volume: 740,456
Feb. 1, 2023 4:00p
P/E Ratio
14.78
Dividend Yield
N/A
Market Cap
$31.34 billion
Rev. per Employee
N/A
loading...
/zigman2/quotes/202291990/composite
US : U.S.: Nasdaq
$ 117.90
+3.60 +3.15%
Volume: 1.82M
Feb. 1, 2023 4:00p
P/E Ratio
43.24
Dividend Yield
0.00%
Market Cap
$17.84 billion
Rev. per Employee
$765,405
loading...
/zigman2/quotes/205000522/composite
US : U.S.: Nasdaq
$ 21.65
-0.04 -0.18%
Volume: 1.04M
Feb. 1, 2023 4:00p
P/E Ratio
1.83
Dividend Yield
N/A
Market Cap
$10.15 billion
Rev. per Employee
$649,518
loading...
/zigman2/quotes/208872451/composite
US : U.S.: NYSE
$ 470,606
-2,394 -0.51%
Volume: 4,413
Feb. 1, 2023 4:10p
P/E Ratio
N/A
Dividend Yield
N/A
Market Cap
$687.89 billion
Rev. per Employee
$794,952
loading...
/zigman2/quotes/200060694/composite
US : U.S.: NYSE
$ 310.57
-0.95 -0.30%
Volume: 3.51M
Feb. 1, 2023 4:03p
P/E Ratio
N/A
Dividend Yield
N/A
Market Cap
$687.89 billion
Rev. per Employee
$794,952
loading...
/zigman2/quotes/207999687/composite
US : U.S.: NYSE
$ 81.14
+1.37 +1.72%
Volume: 2.29M
Feb. 1, 2023 4:00p
P/E Ratio
26.47
Dividend Yield
1.04%
Market Cap
$47.47 billion
Rev. per Employee
$140,256
loading...
/zigman2/quotes/206929371/composite
US : U.S.: NYSE
$ 255.56
+4.70 +1.87%
Volume: 210,448
Feb. 1, 2023 4:00p
P/E Ratio
15.64
Dividend Yield
1.17%
Market Cap
$12.97 billion
Rev. per Employee
$566,452
loading...
/zigman2/quotes/208444467/composite
US : U.S.: NYSE
$ 156.60
+4.77 +3.14%
Volume: 1.59M
Feb. 1, 2023 4:00p
P/E Ratio
21.09
Dividend Yield
1.29%
Market Cap
$21.31 billion
Rev. per Employee
$340,324
loading...
/zigman2/quotes/208031922/composite
US : U.S.: NYSE
$ 239.55
+3.51 +1.49%
Volume: 1.86M
Feb. 1, 2023 4:00p
P/E Ratio
27.35
Dividend Yield
2.19%
Market Cap
$72.51 billion
Rev. per Employee
$347,556
loading...
/zigman2/quotes/207564531/composite
US : U.S.: NYSE
$ 1,401.15
-7.83 -0.56%
Volume: 37,609
Feb. 1, 2023 4:00p
P/E Ratio
N/A
Dividend Yield
N/A
Market Cap
$18.95 billion
Rev. per Employee
$554,809
loading...
/zigman2/quotes/204270015/composite
US : U.S.: NYSE
$ 433.91
+7.16 +1.68%
Volume: 832,943
Feb. 1, 2023 4:04p
P/E Ratio
38.99
Dividend Yield
0.63%
Market Cap
$45.26 billion
Rev. per Employee
$278,332
loading...
/zigman2/quotes/203440310/delayed
CA : Canada: Toronto
$ 2,373.06
+22.29 +0.95%
Volume: 43,247
Feb. 1, 2023 4:00p
P/E Ratio
81.25
Dividend Yield
0.23%
Market Cap
$49.82 billion
Rev. per Employee
$246,057
loading...
/zigman2/quotes/206889364/composite
US : U.S.: NYSE
$ 658.75
+7.09 +1.09%
Volume: 19,634
Feb. 1, 2023 4:00p
P/E Ratio
22.43
Dividend Yield
1.00%
Market Cap
$3.19 billion
Rev. per Employee
$206,855
loading...
/zigman2/quotes/203165245/composite
US : U.S.: NYSE
$ 20.18
-0.19 -0.93%
Volume: 40.10M
Feb. 1, 2023 4:03p
P/E Ratio
N/A
Dividend Yield
5.50%
Market Cap
$145.18 billion
Rev. per Employee
$594,783
loading...
/zigman2/quotes/204653455/composite
US : U.S.: Nasdaq
$ 50.40
+0.90 +1.82%
Volume: 4.55M
Feb. 1, 2023 4:00p
P/E Ratio
N/A
Dividend Yield
1.75%
Market Cap
$26.86 billion
Rev. per Employee
$911,759
loading...
/zigman2/quotes/208054269/composite
US : U.S.: Nasdaq
$ 82.91
+1.42 +1.74%
Volume: 13.14M
Feb. 1, 2023 4:00p
P/E Ratio
42.16
Dividend Yield
N/A
Market Cap
$92.90 billion
Rev. per Employee
$865,405
loading...
/zigman2/quotes/209864107/composite
US : U.S.: NYSE
$ 123.34
+0.87 +0.71%
Volume: 1.43M
Feb. 1, 2023 4:00p
P/E Ratio
37.18
Dividend Yield
N/A
Market Cap
$52.10 billion
Rev. per Employee
$351,093
loading...
/zigman2/quotes/200714911/composite
US : U.S.: NYSE
$ 83.80
+1.45 +1.76%
Volume: 726,405
Feb. 1, 2023 4:00p
P/E Ratio
16.83
Dividend Yield
1.48%
Market Cap
$5.99 billion
Rev. per Employee
$245,667
loading...
/zigman2/quotes/204754445/composite
US : U.S.: NYSE
$ 20.04
+0.37 +1.88%
Volume: 927,021
Feb. 1, 2023 4:00p
P/E Ratio
7.09
Dividend Yield
N/A
Market Cap
$874.71 million
Rev. per Employee
$769,081
loading...

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