An iconic US conglomerate. A multinational healthcare and pharmaceutical giant. A Japanese technology titan. Three different corporate goliaths all came to the same conclusion last week: After decades of consolidation, their paths to future success lie in breaking into smaller pieces.
While M&A activity is at a record high in 2021, last week’s flurry of breakup announcements is a stark example of how corporations are adapting in other ways to shareholder demands, changing customer behaviors — some accelerated by the COVID-19 pandemic — and other factors. And we don’t expect General Electric, Johnson & Johnson and Toshiba to be the last companies to take the major step of splitting up. Here’s why.
- Nimble is increasingly necessary. The era of the conglomerate may not be over, but many corporations are realizing the potential advantages of a carve-out or spin-off. In some sectors, businesses may need more autonomy in response to shifting customer demands due to the pandemic or other factors. And while it may no longer be part of a larger enterprise, a spin-off still can pull substantial weight in its industry. When Pentair spun off its electrical division a few years ago, the stand-alone company was still on the top 50 list of mid-cap companies.
- Capabilities are under the microscope. Leveraging what a company does better than others helps differentiate it in the market, and zeroing in on industry-leading capabilities can reveal growth engines. Our research found that companies that did deals in which there was a capabilities fit between the buyer and target saw higher shareholder returns.
- Shareholders want better results, and soon. Public companies have always had an obligation to deliver positive returns for investors, but the rise of shareholder activism has raised the stakes. Many investors who have consolidated shares in companies have gained more influence and often are willing to challenge traditional business strategies. Aggressive moves to reconfigure an enterprise could be applauded.
- The government is watching. From the Federal Trade Commission to the Department of Justice, the US government has escalated its scrutiny of some companies’ sizes and dominance within certain industries, such as technology. There’s no question that corporate consolidation has increased, and for many large companies — especially those that may want to acquire others in the years ahead — splitting up or slimming down could reduce attention from regulators.
- There’s a lot of money in the market. The Dow Jones Industrial Average, Nasdaq and S&P 500 are all up by double digits in 2021. A persistently healthy stock market could invite other companies to explore if separate businesses can capitalize on that enthusiasm. Or companies could take advantage of generally high valuations and consider selling a business to a corporate or private equity buyer.
Given this environment, here’s what companies should be doing:
- Cast a critical eye on non-core businesses. For many large corporations, portfolio reviews should have started yesterday. Even if all businesses are performing well and generating solid revenue, today’s high valuations require a fresh look at what can help drive future growth — not just in light of financial and market opportunity but also with a focus on a coherent capabilities system. The returns from a strategic sale could help expand core businesses and/or accelerate new initiatives. Or a spin-off may make more sense, as the robust capital markets could reward new entrants that would be nimbler once separated from a parent company. Our analysts found that after tracking fairly closely for much of the past decade, corporate spin-offs have generally outperformed conglomerates in more recent years.
- Avoid rushing and protect value. The breakup boom may increase the itch to reinvent your company, and if a divestiture seems to make sense in your new strategy, invest the time to do it right. The same applies for a large-scale breakup. Failing to fully analyze and understand a business unit’s position — not just operations and finances but also market competitiveness and other external factors — can reduce its value. That just adds more complications to an already complex carve-out or spin-off process.
- Be ready to buy if the deal is right. While you and others try to decide if it’s time to sell or spin, assess your buying appetite. It’s rare for a large corporation to only acquire or only divest, and successful portfolio optimization involves considering all kinds of deals. One company’s decision to slim down could be another’s opportunity to scale up and bolster its position. As you confirm your core businesses and plot new growth paths, preserve your ability to pursue M&A during this breakup binge.
- Prepare for sector shifts. A business freed from a larger enterprise can alter an industry’s competitive dynamics. Anticipating possible spin-offs and carve-outs by peer companies and how you’ll adapt your own business models is crucial for keeping — and growing — your market share. Start planning for those scenarios now, before recent and potential breakup announcements turn into realities in the next few years.