Spinoff City: More Companies Should Shed Subsidiaries, Says Goldman

Activist investors regularly demand that companies spin off a subsidiary, arguing that shareholders will be better served without the one dragging down the other. That, for instance, is what Alta Fox Capital Management wants toymaker Hasbro to do with its Wizards of the Coast and Digital Gaming unit (one title: Dungeons & Dragons).

But to Goldman Sachs, more companies should themselves decide to part ways with noncore subsidiaries, rather than have the likes of Alta Fox mount a proxy fight to force them into a spinoff.

That’s particularly true for businesses with lower-end profit margins on the order of 5% to 10%, plus expected revenue growth of just 10%, Goldman argued in a research note. Almost half the companies in the S&P 500 fit that description, the investment house observed.

By saying goodbye to divisions that aren’t core, such a parent company could double its valuation, the report contended. The Wall Street firm dryly dubbed the notion “self-activism.”

Goldman highlighted 46 companies, with margins trailing their sector peers, which it said would benefit from jettisoning a subsidiary—via a spinoff or perhaps by selling it to one of the special purposes acquisition companies, aka SPACs, hungry for a merger target. Prominent on Goldman’s list were oil giant ExxonMobil, retailer Best Buy, and medical supplier McKesson.

Another Goldman study, of spinoffs between 1999 and 2020, discovered that the departed unit usually was undervalued by investors and yet ended up outperforming the former parent over the next 12 months.

Boosting margins is not easy to do, which broadens the appeal of a spinoff, in Goldman’s estimation. The research report said “it is arguably a more achievable objective than trying to lift sales growth at the same time as US economic growth decelerates.”

Spinoff deal counts were the highest last year, through Nov. 15, since 2011, according to Bloomberg Law, with a 205 tally. This report concluded that “pressure from shareholder activists has played a role in some of these decisions to carve up conglomerates.”

Big names are involved. General Electric plans to divest its health care unit next year and its energy operation in 2024. This maneuver would let GE devote itself to aviation. By the same token, Johnson & Johnson intends to shed its consumer products business, allowing it to focus on pharma.

Overall, spinoffs have been successful as standalone public companies, by the count of the S&P US Spin-Off Index. Over the past 10 years, this index has returned 11.7% annually, just a little less than the broad-market S&P 500’s 14.4%. But such happy news is far from guaranteed.

This rocky year, the spinoff index is down 5.9%, which at least is better than the S&P 500’s 8.8% loss. Last year was better, with a 12.1% showing, although that was slightly less than half what the S&P benchmark logged.