The Rationale of Separate Listing of Units

As mentioned in previous chapters, corporate restructuring is driven by two main motivations: The first is the management's desire to improve the company's profitability and future cash flows; the second is management's desire to increase the market's awareness of the company's activities and value, i.e., to achieve value enhancement or value revelation. In many cases, the main activity is financial restructuring, for example, recapitalization by redeeming the company's public debt, changing the composition of the company's debt, and repurchasing the company's shares in the market. Another activity might be the changing of the company's asset composition, either by buying other companies or divisions of such companies, or by selling assets or divisions of the company, in order to maximize the company's shareholders' return in the short- and long-term, and to assist in increasing the capital market's awareness of the company.

The basic idea behind spin-offs is that listing business divisions separately facilitates a more optimized construction of investment portfolios by investors, their assessment of the company's value, and the compensation of employees in the unit. From the parent company's perspective, the spin-off mechanism also enables the company's management to better focus its attempts to maximize the performance of its core activities.

Similar to the outsourcing phenomenon, which calls for outsourcing of activities that are not among the core-competencies of the firms, spin-offs allow companies to focus on their core activities, and potentially benefit from favorable market valuation of their spin-off units.

The fact that many investors regard the company's value as higher after a spin-off announcement even if no operating improvements are expected in its business results is due to institutional reasons, among others. For example, analysts in investment banks often specialize in a certain field, and companies are usually assigned to the analysts whose specialty corresponds to the field of activity of the company's main division. Therefore, the activities of other divisions in the company are not priced in full. Finally, the spin-off of divisions makes it easier for the divisions to do business with competing companies. For instance, communications companies which compete with AT&T can now buy equipment from Lucent, from which it was spun-off, without many concerns.

However, it is important to note that spin-offs often raise issues with regard to the rights of the company's debt holders. Specifically, a spin-off affects the quality of the company's assets, which may be used as collateral, due to the reduction of its resources (except when proceeds are received by the company). This is one of the reasons that most loan contracts impose restrictions on the distribution of dividends and on material actions pertaining to a change in the ownership of the company's assets.

As mentioned above, one of the main advantages of spin-offs is that they increase the interest of other companies in the field in acquiring the company conducting the spin-off, or of the spun-off unit. In other words, the units become attractive to a larger number of companies since the negotiations become simpler. In many mergers, a substantial part of the negotiations pertain to plans for reorganization after the merger, whereas here the asset in which the buyer is interested may be separated from the outset.