Financial Times - Let’s all do the corporate hokey-cokey

There seems to have been an outbreak of the hokey-cokey participation dance song among companies lately. You know, the one where you put your right hand in, take your right hand out, shake it all about and so on.

 

The most prominent tendency lately seems to be to split companies into smaller enterprises, predominantly in the US but also closer to home. Even in the limited number of sectors and companies in which Fundsmith seeks to invest, there has been a rush to demerge. Just this week, Unilever announced the spin-off of its spreads business, but we have also seen:

 

● ADP, the payroll company, spin off its car dealership software business CDK

● eBay’s announcement that it will separate its Marketplaces and PayPal businesses

● Kimberly-Clark, the tissue and nappy manufacturer, planning to spin off its healthcare business

● Procter & Gamble announcing its intention to spin off its Duracell battery business and then selling it to Warren Buffett’s Berkshire Hathaway

● Reckitt Benckiser’s decision to float its pharmaceutical business, to be called Indivior

 

And just to maintain the symmetry of the song, Coca-Cola is going through one of its periodic volte-faces on whether it is good or bad for it to own its bottlers by buying back stakes in them, many of which it had previously sold. It seems that sometimes not owning bottlers is good because it is a capital intensive, low return business. At other times it is essential to own them in order to control distribution. Coke is so bipolar on this issue that it could perform the corporate M&A Hokey Cokey all on its own.

 

In some cases the urge to demerge seems to result from the conclusion that the company had two or more completely different businesses which did not produce any synergies and might have better futures and/or higher valuations apart from each other. One might wonder why this thought did not occur to anyone when the businesses were being acquired. Part of the answer lies in so-called shareholder activism.

 

Activism can take many forms and mean different things but often it involves a shareholder buying a stake in a company and then agitating for change, either via the media or through corporate governance channels.

 

Sometimes that change does not involve separating a company into smaller component businesses, but rather it aims to get the company to put itself up for sale. We saw this in 2011 when veteran US activist Carl Icahn made a bid for Clorox, the US household cleaning products company, in an effort to get them to sell themselves. More recently we have seen an activist make a public appeal to the board of InterContinental Hotels to put the company up for sale.

 

Activism definitely has a role in promoting shareholders’ interests but too often it involves an attempt by the activist to get the company to do a deal which will generate some excitement among the analytical community and so enable the activist to sell its stake at a profit. All very exciting, but not of much use to long-term shareholders like us who are left with holdings in fragmented businesses, often with new management teams and strained balance sheets. Then there are the huge frictional costs of separation fees to investment bankers, lawyers, accountants and others — followed by financial statements that contain so many adjustments that they border on the incomprehensible.

 

But sometimes seemingly frenetic merger and demerger activity is dreamt up by the management of the company all by itself. A classic case is Mondelez. It is the product of Kraft’s controversial takeover of Cadbury in 2010, which was followed just two years later by the demerger of Kraft and Mondelez which consisted of Cadbury plus Kraft’s snack businesses. Hardly any analysts queried why it was a good idea to demerge two businesses which it had only combined two years previously, and if you can follow the logic in all of this you are ahead of me.

 

The result of Kraft’s hyperactivity was that the 2013 results for Mondelez — the first post-demerger — contained 19 schedules of adjustments and reconciliations to its reported numbers. This legerdemain had not ceased by the first quarter of 2014, when it gave 11 adjustments, magically turning reported growth of operating profits from 1.1 per cent to 15.8 per cent. And for my next trick . . .

 

There have of course been the usual restructuring programmes and integration programmes, and the Hokey Cokey activity has not slackened with the announcement this year that Mondelez is now spinning out its coffee business into a joint venture with D.E. Master Blenders called Jacobs Douwe Egberts.

 

At least all this is bullish for investment bankers’ bonuses.

 

Click here to view the article in FT.com

 

Terry Smith

 

Financial Times