M & A CritiqueIn last September’s edition we covered a topic “Conglomerates – Corporate Dinosaur: On their Way to Extinction?” where we discussed various reasons for decreasing number of conglomerates, one of them being increasing complexities in doing modern day businesses which require high level of focused skill sets and core competency in finance, HR, and other general functions unlike earlier where general skills to manage business were enough to give long term sustainability to many businesses.
We also discussed various strategies to handle such situation like splitting up the business, hiring specialized people for each division, selling off the non performing businesses etc. which depends on a range of factors mostly related to management and types of business in which the corporation is present.
Developments
In relation to foregoing recently, Brilliance China Automotive Holdings is aiming to spin off its engine manufacturing unit, in which it owns 42.5%, for a separate Hong Kong listing. According to a source, the deal may raise about $100 million. Some 25% of the unit, which is called Xinchen China Power Holdings, will be sold to the public, reducing Brilliance China’s stake to about 31.9%.
Brilliance China is a Hong Kong-listed red-chip that makes cars, minibusses and auto components. It operates a car-making joint venture with BMW and a minibus-making joint venture with Toyota. The company hasn’t outlined what it hopes to achieve with the spin-off, although Xinchen China is in the process of constructing new production facilities in the Sichuan province and some of the money raised from the IPO will likely go towards this project.
When these new facilities become fully operational in September this year, they will boost Xinchen China’s production capacity to 300,000 engines per year, from 255,000 at present.
Elsewhere, property development and highway infrastructure company Hopewell Holdings said before the Chinese New Year holidays that it has obtained approval from the Hong Kong stock exchange to spin off its wholly-owned property development and hospitality business in Hong Kong through an initial public offering. The listing of the unit, which will be named Hopewell Hong Kong Properties, is expected sometime in the second quarter. The company officials said that the spin-off will create a more defined business focus both for Hopewell HK Properties and for Hopewell Holdings itself, which will be focusing mainly on property development and investment in China. The parent company also owns a 1.2 GW coal-fired power plant in the Guangdong province and a 68.1% stake in Hong Kong-listed Hopewell Highway Infrastructure, which builds and operates expressways, tunnels, and bridges in China’s Pearl River Delta region. The separate listing will help establish Hopewell HK Properties as a pure-play premium property platform and brand in Hong Kong, and will increase its financing flexibility by giving it direct access to the capital markets. It will also provide better clarity of Hopewell HK Properties’ credit profile for rating agencies and financial institutions that wish to lend against the credit rating of a Hong Kong development and investment company, Hopewell said. The money raised from the IPO will be used mainly for capital expenditure for projects already under development, such as Hopewell Centre II — its HK$9 billion ($1.2 billion) hotel and commercial project in Wan Chai — as well as for future opportunities.
As with all spin-offs, the parent company also hopes that the spin-off will release hidden value for its existing shareholders. Hopewell didn’t specify how much of Hopewell HK Properties it intends to sell, but said it expects to remain the controlling shareholder with a stake of at least 51%, meaning that it — and its current shareholders — will benefit from any increase in valuation of the property unit as well as from its performance and future growth.
The fact that two Hong Kong-listed companies are looking to spin off parts of their existing businesses at roughly the same time suggests that issuers are starting to feel more comfortable about the state of the Hong Kong IPO market, following a poor sentiment for new listings during most of the last year. Six companies have raised a combined $798 million from Hong Kong listings so far this year, with almost half coming from the $399 million IPO of Greenfield mining company Chinalco Mining Corp International.
Spin-Off & IPO
As can be seen from the above examples that a large number of conglomerates across the globe have chosen this strategy i.e. Spinning Off their unrelated and in some cases integrated businesses and going for an IPO. There are number of advantages to such a transaction –
- Unlocking of Hidden values: There may be cases where a company has an excess of cash and they decide to make investments in other companies. As per rules of accounting an investment made is recorded in the books at the price at which they were made and not at market value. This can be depressing for a company where the investments made show positive signs. In that case, the company can simply demerge and float a company which would take care of the investments made earlier. E.g. a case of Jindal Saw demerging its investment business (cover by us in our July 11’ edition).
This not only reduces the burden from the shoulders of the management but also get to know the true value of their investments.
- Removing the Non Performing Businesses: Many a time the overall value of the company which is into multiple businesses does not show the exact picture of its performance. This is mainly due to one or more non-performing business divisions which affect the overall valuation of the company. By following this strategy they can project the true picture of the group.
- The source of Funds – Quite often a given division suffers a due to lack of funds even though the division does have the technology to offer superior products than their competitors. By following this strategy they not only reduce a burden of the management but also invite new investors to be part of the growth story.
- Strategic Players – While making an investment especially in the case of strategic tie-ups the companies are interested in making an investment in a given division where their expertise lies. This strategy can help invite new strategic players which otherwise would have been reluctant to part of the complete group.
- Increasing their range of Businesses – Companies go for captive consumption for the purpose of absorbing the goods produced by their divisions. As a result, they might be missing out on advantages being offered by similar products present in the market. By splitting up divisions they have the option to choose from. Similarly, if the product manufactured by a division is superior in quality to that offered by other companies then by following this strategy they not only get the funds to expansion but are able to tap new customers where they can sell their products at a much higher price thus adding more value to the company.
- Exit Strategy – Incase a management wants to get out of a particular business they can use this strategy rather than adopting a pure slump sale of a business which would otherwise have a huge tax implication. At the same time, the minority shareholders have a say in the developments rather than being completely neglected.
Check out our Article on
Conglomerates – Corporate Dinosaur: On their Way to Extinction?
Impact in Indian Industry
Considering the fact that a large number of businesses are family run and most of them are conglomerates, this strategy can be of great help in order to maximize shareholders wealth. This strategy also takes care of the interest of the minority shareholders who are mostly neglected at the time of major developments.
Recently, WIPRO one of the major business houses in India followed a similar strategy. They demerged their FMCG & Infrastructure business from their IT business in order to focus individually on each business. At the same time, it gives options to existing shareholder and even new investors to choose which company to invest in (As of now WIPRO hasn’t decided to list FMCG business but we expect them to list the business in near future. Details can be seen from our last Month’s edition).
Recently another Indian business house MARICO also followed similar strategy i.e. demerged their Skincare solutions into a separate entity which they would be listing. Following the announcement, the company’s stock rose to an intra-day high at Rs 230 on the BSE, before closing the day’s trade at Rs 227.45, up 1.36 percent.
Conclusion
In modern times when businesses dynamics are changing at a high pace, shareholders are becoming more demanding suddenly Conglomerates appear to be the things of the past. Conglomerates are actively looking to split their businesses and go for independent listings. Though this strategy is much more expensive as compared to other strategies to execute, in a long run they offer much more advantages as compared to other strategies.
