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What Is a De-Merger?
A de-merger is a form of corporate restructuring in which a business is broken into components. These units operate on their own or may be sold or liquidated as a divestiture. A de-merger allows a large company to split off its various brands or business units to invite or prevent an acquisition, to raise capital by selling off components that are no longer part of the business’s core product line, or to create separate legal entities to handle different operations.
Key Takeaways
- A de-merger is when a company splits off one or more divisions to operate independently or be sold off.
- It may take place for several reasons, including focusing on a company’s core operations and spinning off less relevant business units, to raise capital, or to discourage a hostile takeover.
- The spinoff is the most common type of de-merger, which results in the parent company retaining an equity stake in the new company.
How De-Mergers Work
The operations of a small business may be simple. When companies grow, their business structures become more complicated with different segments and business lines. Larger entities, such as conglomerates, may make acquisitions and, at times, may have to shed some of their units to keep in line with their business plans. This is where the de-merger comes into the mix.
As noted above, a de-merger is a strategy that leads the restructuring of a company so it can refocus its efforts on the most profitable components of its business. This involves breaking up certain units from the core business and preparing them to be spun off, sold, or liquidated.
Individually, de-mergers can happen for a variety of reasons, one of them being that management knows something that the market is unaware of and wants to address an issue before it finds out. This is evident in that corporate insiders tend to profit from de-mergers. De-mergers allow companies to:
- Refocus on their most profitable units
- Reduce risk
- Create greater shareholder value
- Have specialists manage specific business units or brands rather than generalists
De-merging also allows companies to separate underperforming business units that create a drag on their overall performance. Although they can create some complicated accounting issues, de-mergers can create tax benefits or other efficiencies. Government intervention, such as to break up a monopoly, can spur a de-merger.
Analysts tend to discount parent companies that hold multiple subsidiaries by roughly 15% to 30% due to less than transparent capital allocation.
Types of De-Mergers
There are several types of de-mergers that companies can execute. The following are the most common types:
Spinoff
One of the most common ways for a de-merger to be executed is a spinoff. This step occurs when a parent company receives an equity stake in a new company equal to their loss of equity in the original company.
At that point, shares are bought and sold independently, and investors have the option of buying shares of the unit they believe will be the most profitable. A partial de-merger is when the parent company retains a partial stake in a de-merged company.
Split
A split is like a spinoff but with multiple components. It occurs when multiple businesses are split from the parent company into different entities. If the company is public, shareholders of the parent company are given the option of trading in their shares of the parent company to those of the newly created entity(s).
Liquidation De-Merger
As the name implies, a liquidation de-merger involves liquidating the business unit in question. Assets are divided among the new companies. It usually happens when there are conflicts between management, board members, and/or shareholders about the direction of the business, allowing new companies to be created so their visions can be met.
Advantages and Disadvantages of a De-Merger
Executing a de-merger comes with certain benefits. But there are downsides and risks associated with this type of business strategy. We’ve listed some of the most common pros and cons that come with going through a de-merger.
Advantages
There are many reasons why companies choose to do a de-merger. One of the most common—and the most notable advantages—is that it boosts shareholder value. Investors receive shares in the new company and certainly reap the financial benefits if and when the new entity becomes profitable.
Newly de-merged companies can take control of their futures. This means they can make important investment decisions, raise capital, conduct research and development (R&D), and make marketing choices on their own without the need to consult with the parent company.
Disadvantages
There are often steep costs associated with de-mergers. Going through the process may lead to the possibility of increased tax issues. The de-merger must adhere to certain processes and procedures reserved for corporate restructuring. Failure to do so may lead to additional tax liabilities for the new entity.
Shareholders must approve of the move to restructure the company. After all, it does affect their financial position and interests. There is a chance that they may not approve of the de-merger, which can put a damper on the company’s growth in the future.
Examples of a De-Merger
A common de-merger scenario would see a utility separate its business into two components: one to manage its infrastructure assets and another to manage energy delivery to consumers. Spinoffs were very popular in 2014, with nearly 50 occurring in the U.S. alone—many of them in the utility and solar power sectors.
Real-World Examples
The following are some notable real-world examples of de-mergers:
- Walmart (WMT) sold European retailer Asda to Issa brothers and TDR Capital in 2021. The corporate giant does retain an investment interest in Asda.
- Australian airline Qantas split its international and domestic operations via demerger in 2014. Each unit is run separately.
- Dr. Pepper Snapple Group was created in 2008 after Cadbury Schweppes spun off its U.S. beverages unit. In 2018, it was acquired by Keurig Green Mountain, which became Keurig Dr Pepper (KDP).
- British Telecom conducted a de-merger of its mobile phone operations, BT Wireless in 2001. The move was an attempt to boost its stock performance. British Telecom took this action because it was struggling under high debt levels from the wireless venture.
Is a Spinoff a De-Merger?
A spin off is a common type of de-merger. In a spinoff, a (parent) company creates a brand new company from one of its business units. The rationale is that the newly formed entity becomes more profitable as a standalone company. If the company is public, new shares are created and issued to shareholders of the parent company.
Do De-Mergers Create Value for Shareholders?
That depends. Share values may drop in the period immediately following a de-merger. However, the stock often recovers because the businesses of the parent and new entity(s) are more streamlined and focused. Another key point to consider is that any drop in the parent company’s stock may be made up by the positive performance of the new company’s stock.
What Do De-Mergers Make Sense?
As the name implies, a de-merger is a business restructuring strategy that involves taking a business unit and spinning it off, splitting it, or liquidating it from the parent company to form a brand new unit that stands on its own.
This strategy makes sense when market conditions favor the move so the new business can function on its own as a profitable entity, when it unlocks shareholder value, when there are very clear and realistic plans for success, and when all of the tax implications are considered.
The Bottom Line
We often hear about mergers and acquisitions in the business world. But de-mergers can be quite as common. De-mergers occur when business lines or segments are divested from the parent company to create brand new entities. The hope is that this type of restructuring boosts shareholder value and allows management to focus on the new company’s profitability.