kraft

The spinoff boom is a boon for this economy

October 21, 2011: 5:00 AM ET

Job creation, innovation, and shareholder value: Who said breaking up is hard to do?

FORTUNE -- Not too long ago the prevailing corporate buzzword was "synergy." Combine one business with another, eliminate redundancies, and watch the profits accumulate. Not all mergers would succeed, of course, but two heads would usually prove better than one, particularly at companies where revenue and innovation had stagnated.

In 2011, however, a growing number of large companies are challenging the synergy gospel by spinning pieces of their business off into independent entities. Earlier this week, Abbott Laboratories (ABT) announced plans to split into two separate companies next year. Twenty companies listed on the New York Stock Exchange or Nasdaq announced spinoffs through early October, including such well-known names as Kraft (KFT), ConocoPhillips (COP), Expedia (EXPE), McGraw-Hill (MHP), and Sara Lee (SLE). That compares with just 13 such spinoffs in all of 2010, and only 12 in all of 2009, according to data analysis firm CapitalIQ.

There are two basic explanations for the recent spinoff boom -- one sober, one cynical. Either way, the results are good for America's economy.

The sober explanation is that spinoffs reflect a broader slowdown in U.S. merger-and-acquisition activity, which is off by around 25% from last year.

"Even the deals that do get done are taking much longer," explains Joe Gromacki, an M&A attorney with Jenner & Block. "Spinoffs may be preferable to auctions or other sales processes because they are internally driven, without a counterparty that may be susceptible to public-market volatility."

The more cynical explanation, of course, has to do with boosting share prices. Take the case of McGraw-Hill, which announced plans to spin off its education business in September. The company's shares closed up 4% on the day of the announcement, and finished the week up nearly 17%. I'm not suggesting that such massive decisions are primarily driven by short-term share juicing, but I'm also not so naive as to ignore its role in the final calculus.

To spin off or not to spin off is not an easy question to answer, especially in a shaky economy. Ask a banker and he'll probably advise breaking up. In the case of Kraft, bankers have reaped windfalls over the years as the conglomerate has spun off and then acquired one business after another. HP, which announced plans to spin off its PC business this summer, is now reportedly reconsidering the move after replacing its CEO.

Spinoffs are markedly different from traditional sales of noncore or underperforming business units. Those deals are effectively a wash, since one company's loss is another company's gain. In a spinoff an entirely new organization is created.

There are several reasons the spinoff boom is a boon for today's sluggish economy. First, many of these companies are flush with cash, which has led shareholders to wonder about the return on that value. Spinoffs help accomplish that end, particularly since distributing the stock of a subsidiary or other company-owned business is usually tax-free. Moreover, the new company often is undervalued at the time of spinoff because it isn't in the hands of what Gromacki refers to as its "natural owners." That means shareholders get extra shares they can later sell for a higher price.

There's another plus: Smaller organizations tend to be nimbler and more innovative. If we want better products, we should want more spinoffs.

Finally, the job redundancies created by mergers can become job openings in demerging -- in back offices, middle management, sales, and more. After the financial services company Synovus (SNV) spun off its credit-card-processing unit, Total Systems Services (TSS), in 2007, the two companies' combined payroll increased by more than 9% by the following year.

The preference, of course, is for existing companies to add payroll or for startups to create jobs out of whole cloth. But at this particular moment, any baby step in job creation should be welcomed.

So go forth, corporate America. And multiply.

This article is from the November 7, 2011 issue of Fortune.

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