Breaking up might be hard to do, but itâ€™s sure getting popular again on Wall Street.
Helped by the momentum in the economy and improving credit markets, itâ€™s becoming fashionable to break up highly-diversified conglomerates as a mechanism to unlock shareholder value.
In recent weeks, 90-year old ITT (NYSE:ITT) announced plans to break itself apart, iconic electronics maker Motorola started trading as two separate companies, Fortune Brands (NYSE:FO) revealed plans to get rid of its golf division and General Electric (NYSE:GE) has received approval to spin off NBC Universal.
The breakup trend seems likely to put pressure on other stretched-thin conglomerates to spin off some of their non-core assets and could be a boon to fee-hungry Wall Street investment banks that are tapped to do the dismantling.
â€śI think the large conglomerate could potentially be a thing of the past,â€ť said Sheldon Stone, a partner at boutique banking firm Amherst Partners.
To be sure, there are many examples of successful companies that are highly diversified and there is a risk in breaking apart a well-operating conglomerate with vast synergies. But diversification seems to have lost favor in many corners.
At conglomeratesâ€™ height in popularity during the 1960s, corporate America believed diversification would help bottom lines by creating synergies and cross-fertilization. In many cases that theory didnâ€™t pan out, leading many conglomerates to break themselves apart during the merger movement in the 1970s.
â€śThe advantage of the conglomerates seemed to go out the window,â€ť said Richard Sylla, an economics professor and financial historian at NYUâ€™s Stern School of Business.
The most famous example of a breakup may be John D. Rockefellerâ€™s Standard Oil, which was forced by the Supreme Court in 1911 to be dissolved into 34 companies. Even though it wasnâ€™t voluntary, Rockefeller made a lot of money.
â€śRockefeller was never as rich as he was until two years after they broke up his company,â€ť said Sylla.
It remains to be seen if todayâ€™s breakups will go as well as Standard Oilâ€™s, but shareholders are already cheering the moves. Shares of ITT surged 16% to two-year highs after it unveiled plans last week to break into three publicly traded companies that focus on water, defense and engineering.
Likewise, Motorolaâ€™s new companies -- Motorola Mobility (NYSE:MMI) and Motorola Solutions (NYSE:MSI) -- enjoyed strong debuts on the Big Board earlier this month.
Even blue-chip conglomerate GE is selling control of NBCU, which contains a slew of TV networks, film house Universal Studios and even a theme park.
Companies may decide to sell off their parts for a range of reasons: to raise cash; get rid of unprofitable divisions that drain resources; fix deals that fail to generate anticipated synergies; or to unload headache units that need to be micromanaged. Ultimately, the goal remains the same: break apart to â€śunlockâ€ť shareholder value.
Of course, the economy has a lot to do with why companies like ITT and GE have decided to unload some of these divisions now.
It would not have made sense to auction off struggling businesses during the depths of the downturn two years ago when the amount investors were willing to spend on acquisitions --typically a given multiple on their cash flows -- was much lower than now. It would have been like selling at the lows. Thanks to vastly improved growth prospects, buyers are willing to pay substantially higher multiples than just two years ago.
At the same time, the demand on Wall Street for initial public offerings has also ramped up, underscored by the successful IPO of General Motors (NYSE:GM).
The ability of companies to spin off their less-desirable parts is also evidence of how much the credit markets have improved because many of these deals need access to financing that simply wasnâ€™t available in recent years.
â€śItâ€™s a sign the worst of the financial crisis is pretty far behind us,â€ť said Sylla. Back in 2008, â€śIf a bank had a lot of money, it didnâ€™t want to lend it because it was scared out of its mind.â€ť
The financial crisis itself also underscored the downsides to big financial supermarkets, namely Citigroup (NYSE:C), which CEO Sandy Weil imagined would serve as a place for customers to receive a range of financial products all under one roof. However, the model and overleverage ended up nearly killing Citi, and the result was a $45 billion taxpayer bailout.
More Breakups on the Horizon
Wall Street firms like Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and JPMorgan Chase (NYSE:JPM) stand to gain from the breakup trend as their investment bankers charge fees on the complicated transactions.
â€śI laugh and chuckle because Wall Street makes its money either way. You can put companies together or take them apart -- fees come in either way,â€ť said Sylla.
The positive investor reaction to the breakup plans of ITT and other companies could put the heat on other companies to split themselves apart too.
â€śThere will be some pressure, absolutely,â€ť said Larry Hrebiniak, a management professor at the Wharton School of Business. â€śBoards and shareholders will follow.â€ť
Hrebiniak, who worked for a GE aerospace division that was sold off to Lockheed Martin (NYSE:LMT), predicted GE shareholders may call for that conglomerate to unload its health-care or appliances divisions next.
Illinois Tool Works (NYSE:ITW), which has its hands in everything from power tools and packaging to food-service equipment, has also been mentioned as a possible breakup candidate. The same is true for Tyco International (NYSE:TYC), which makes steel tubing, owns security leader ADT and manufactures touch-screen displays.
Another company that could come under pressure is software titan Microsoft (NASDAQ:MSFT), which has seen its stock price rise just 6% over the past 10 years despite its $243 billion market cap and a near-stranglehold on the operating system market.