News Corp demerger: why companies split up their businesses
Wednesday, June 27, 2012/
Rupert Murdoch’s News Corp has confirmed it is considering a demerger of its entertainment business and its newspaper mastheads. The newspaper business — the font of Murdoch’s empire and once the jewel in his crown – is struggling to compete with the profits delivered by the entertainment businesses. The chief operating officer, Chase Carey, is reportedly a champion of the idea while Murdoch was against it – until recently.
Business conglomerates – like Wesfarmers – were once in favour, as a way for companies to mitigate business risk. Today, fund managers prefer to manage their own risk, buying their own diversification.
Changes to investment strategies is one factor driving demerger, but there are several others.
The dog and the star
News Corp’s demerger is an example of this reason. The newspaper business is facing an uncertain future as part of a media industry in chaos, with a business model that no longer makes sense.
At the same time, there is the risk of moral contagion and brand risk from the phone hacking scandal that erupted at News of the World, in which journalists and editors are accused of illegally hacking phones to get stories, and which is now the subject of an inquiry in Britain and has led to high-profile arrests. “That is probably the most common reason for demerger,” Douglas Dow, associate professor of business strategy at Melbourne Business School, tells LeadingCompany. “You have an underperforming portion of the business and you want to get rid of it.”
The problem is that no one wants to buy a dog. “These are the hardest businesses to sell. It sounds good but you have few buyers,” says Dow. “That is the reason Coles Myer struggled for so long [before selling Myer to private equity company, TPG, which later listed it again]. Coles would say Myer is dragging us down, but there were no buyers.”
Fosters, another dog and star example, demerged with its underperforming wine business – it became Treasury Estate Wines – in favour of its solid beer operations.
Recently Microsoft paid $US1.2 billion ($1.18 million) for Yammer, an online social network for enterprises. Yammer makes very little revenue, like Facebook, but both are still perceived to be very valuable (despite the slide in Facebook’s share price since listing last month).
However, if Yammer had a bricks-and-mortar business, perhaps delivering revenue but burdened by more costs, its value would have been less, says David Knowles, a partner with accounting practice Pitcher Partner. “If Yammer had been in a traditional business structure, it would not achieve the price earnings multiple that resulted in a $US1.2 billion valuation,” Knowles says. “The talent is to spot the value that is in the business – a piece of technology, a way of doing things, that the buyer can see how to use.”
Too complicated for investors to understand
A company may have several strong business divisions, but the risk and value of each is difficult for investors to understand, says Knowles. “Modern financial accounting does not give you the detail necessary to assess the risk and value of each business,” he says. “There are shared costs that are difficult to allocate from the outside.”
A mid-sized listed company called Vision Systems, sold in 2006, illustrated this point. For decades it had multiple businesses, as many as six, and failed to build its share price, despite being profitable. Its value was around $400 million, when the company sold off one division for $228 million – double the independent valuation. The share price for the remaining business tripled in the ensuing bidding war and the wholesale price was around $700 million.
“I have many family business clients with multiple interests,” says Knowles. “A father will have two sons, and want to give the primary business to the one who shows an interest. To make it fair, he will give property or a subsidiary to the other.”
There is an element of this in the News Corp deal. News COO, Chase Carey, is an obvious contender as CEO for the entertainment business, with Rupert Murdoch retaining the newspaper business, perhaps succeeded by James Murdoch.
Dow says: “Succession is not a commonly stated reason, but it may be an underlying one,” he says. “You get into the grey area of egos, but if you want talented management, would an ambitious CEO want to lead a stand-alone business or a subsidiary, answering to its head.”
Businesses with a single market have a clearer management focus. Knowles says his company, Pitcher Partners, demerged from its parent, KPMG, in 1991. “Our reasons were our marketplace. We were focused on the mid-market and by demerging, we have grown enormously,” he says. KPMG has also grown.
In companies with a single focus, the management team is clearly aligned with and understands its customers, attracts employees with the specific skills needed, and deploys the right systems and technology to deliver its products and services to the market.
“It makes an enormous difference to the way a business performs,” Knowles says. “A conglomerate is less agile, its overarching framework of bureaucracy slows it down and impedes innovation.”
Fairfax Media has sold 49% of TradeMe, one its best performing businesses, which is listed on the New Zealand stock exchange, and last week sold a little more to raise $160 million, which it needs for the massive restructure of its newspaper businesses, that will see 1900 jobs go.
“If you want to raise cash to pay down debt, for example, you have to sell the best performing businesses,” Dow says. “Of course, it all depends on the price you get.”
Surfwear company, Billabong, has been widely criticised for selling its best brand, Nixon, after rejecting a private equity bid. “If you get a brilliant price, no one will complain, but if you are desperate, you are already behind in the negotiations,” says Dow.
Conflict of interest
In the aftermath of the collapse of HIH Insurance in 2001, three of the big four accounting firms sold their consulting businesses – KPMG, Ernst & Young and PwC. The reason was that consulting firms were seen to have conflicting interests with the audit businesses within the big accountants. This perception of conflict also lead the big four firms to demerge their insolvency and legal practices. Deloitte was too late to sell its consultancy, but had much fewer audit clients and was able to keep its consultancy practice under separate leadership.
Perceptions of conflict change. Today, all the big four are rebuilding their consulting divisions up again.
Businesses are too different
Tabcorp Holdings last year demerged Echo Entertainment. Tabcorp’s wagering, gaming and keno businesses were deemed to be too different from Echo’s business of owning and operating casinos in New South Wales and Queensland. When businesses within a company are too different, they can hold each other back, says Dow. “There is no value in being together and they hamper each other.”
Do shareholders win?
British research suggests that shareholders can win from demergers … but they need to back the spin-off, not the parent. A London School of Economics study of 48 demergers in Europe found that after a demerger, the spin-off outperformed the market by +17.3% over the three subsequent years, while the parent underperformed by -5.9% over the same period.