Demergers get no respect but study finds they boost value

Corporate demergers create significant value for shareholders in both the parent company and the demerged, or separated, entity within a year of the deal being completed, a new survey has found.

The Deloitte & Touche survey found that while demerger announcements are usually greeted with a two to 10 per cent drop in share price, there is a dramatic turnaround within a year of the demerger.

The share price of most parent companies increases from 12 per cent to more than 52 per cent, while the separated business also fares well, with share price rises of 13 per cent to more than 46 per cent.

"Currently, there is a lack of understanding about them [demergers], which partly explains the dip in share price on announcement, with investors fearing a loss of scale and that assets will be sold cheaply," said Angus Knowles-Cutler, a partner in merger integration services at Deloitte & Touche. "In reality, the potential diseconomies of scale for both separating entities are far outweighed by clarity of purpose provided by the demerger. Management is able to focus on the core business, decision making becomes easier, and motivation rises with greater sense of ownership of the smaller business and shared sense of direction," he said.

Conversely, he said the opposite can be true of mergers. Acquiring businesses that are greeted with share price rises of 3 per cent or more following the merger announcement fail to increase value in year one, while those greeted with a share price drop under-perform even further.

"The frequent hike in share price on announcement of a merger is often justified [because] the rationale behind the deal is well founded. The problems often come from clumsy integration, which has a habit of destroying focus and motivation – the factors that make demergers successful," said Mr Knowles-Cutler.

The Deloitte & Touche survey was based on an analysis of the 118 biggest demergers carried out worldwide between 1990 and 1999. More recently, the UK telecoms giant BT, headed by Ben Verwaayen, demerged its mobile phone unit BT Cellnet. Shares in the unit, now called mmO2, started trading independently of their parent on the stock market last November.