By Richard Halle
The thought of a ‘Brexit’ conjures up images of a drawn out, messy divorce for most – a painful process, with a net negative result. However, I believe that there are reasons to be hopeful. I think a positive analogy can be drawn between the spin-off of a company from a larger bureaucratic parent and that of the UK’s decision to exit Europe.
The spin-off phenomenon is well documented. Spin-offs typically lead to abundant value creation. This phenomenon is evident across geographies. In Europe alone, there are plenty of recent examples of this tailwind; Fnac, Euronext, Covestra, Arkema, Indivior – to name but a few.
As a result of this phenomenon it’s now even possible to invest in a spin-off ETF. One such index is the S&P 500 spin-off index. The empirical result of this value creation tailwind is evident below.
The primary reason why spin-offs outperform is the liberation a company experiences once it has been unshackled from its ‘vampire’ parent.
Following a spin-out, the newly-created entity is liberated from the burdensome, restrictive rules and bureaucracy of the larger corporate parent. The outcome is a more agile and responsive company. Management are in charge of their own destiny, better focussed and free to do as they see fit to best add value. Employees are often more liberated and motivated to work for a smaller entity with which they identify.
Alongside this greater agility, is an improved entrepreneurial spirit. The newly spun-out entity is forced to either thrive and survive, or die. Such an environment is often inspirational in fostering innovation, as the recently spun-out entity can no longer rely on the safety/support of its larger parent.
I believe both of these factors boost the chances of a company competing and succeeding in a fast changing competitive landscape.
Interestingly, the probability of a spin-off outperforming is even higher where the parent entity is underperforming/unprofitable. The market has historically rewarded turnarounds and restructuring-related divestments.
Brexit – a source of value creation?
Does this spin-off tailwind however apply on a much larger scale? Whilst the spin-offs listed above have all been reasonably large-sized deals, the largest spin-off EVER is the one that we’re likely to live through within the next two years – Brexit.
As such, I believe similar analogies can be drawn between company spin-offs and the UK’s separation from its bureaucratic (and far from thriving) European parent. If the empirical evidence of spin-outs is anything to go by, Britain could outperform as it’s unshackled from its large sclerotic parent. And it’s not all bad news for Europe either; the shares of the parent company typically also perform more strongly following the spin-off – it seems that both the parent and the problematic child are better off alone. With most company spin-offs though, both parties are generally happy with the decision, whereas with Brexit the parent isn’t keen and large parts of the subsidiary aren’t either. That doesn’t negate the argument that the spin will work, but it will make it harder.
Whilst there are many uncertainties surrounding Brexit, including the timing and format that it will eventually take, I do not believe that Brexit should be viewed as an inevitably value destructive, messy divorce. Similar to company spin-offs, whilst there might be heightened volatility and uncertainty immediately following the spin-off, the long-term outlook could well be much stronger. Both Europe and UK could become more streamlined, entrepreneurial and productive entities.
Who knows, this might even set a precedent and be the start of more ‘spin-offs’…?