Demergers are currently in vogue

The phenomenon of companies demerging is being widely talked about at the moment, given the large number of transactions currently planned. Latest examples include Thyssen-Krupp, Siemens, General Electric and DowDuPont. Activist investors are often behind this, pressing for a demerger, or a company’s management hits on the idea without external stimulus.

Managment and/or investors argue that, due to their complexity, conglomerates are valued with a so-called conglomerate discount versus specialised rivals. A demerger would put an end to this discount. The individual parts would then be worth more than the combination of the company parts. Another argument in favour of demerging from the investor’s viewpoint is the resultant possibility of being able to invest more specifically in certain business areas.

By demerging, greater focus can be placed on a more or less narrowly-defined business area. In a favourable case, this can be a reduction in organisational complexity, the ability to structure decision processes more quickly and efficiently and thereby enable the company to respond in a more agile way to challenges and grow more strongly. The possible disadvantage is that the company becomes less-diversified, making it more susceptible to fluctuations in the particular business area. Another drawback is that it might no longer be possible to realise synergies (e.g. in purchasing, logistics, production) between the various business divisions.

Whether the advantages of a demerger outweigh the disadvantages can only ultimately be assessed in an individual case. According to our estimate, however, many major conglomerates probably face high complexity costs, a factor signalling good prospects for creating shareholder value by way of demerger. The current high share prices and valuations are also increasing the willingness of management to divest company parts not required for the original business purpose.

A distinct trend towards demerging and specialisation has been evident for years in sections of the chemical sector.

Due to growing competition above all in the emerging markets (e.g. China, Middle East), competition in commodity chemicals (upstream business) has intensified. For chemical companies from the industrialised countries, differentiation therefore became crucial for future business success. A higher degree of differentiation can be particularly achieved in the downstream business (specialty chemicals). The highly-technological production processes (market entry barriers), greater customer proximity and lower cyclicality make the business with specialty chemicals appear more attractive. For chemical groups, the transformation into a specialty chemicals supplier thus moved into strategic focus, with the emphasis placed on developing entire value chains. With this transformation, chemical companies used demergers, split-offs and spin-offs to dispose of activities that were not an integral part of a narrowly-defined business/product area.

At the same time, however, the market also started consolidating in chemical business areas that were already highly-specialised. For example, the industrial gas business has become strongly concentrated as a result of the acquisition of Airgas by Air Liquide and the merger between Linde and Praxair. In the agro-chemical sector, the number of big players has also fallen from six to only four as a result of M&A transactions (Syngenta acquisition by ChemChina, the planned Monsanto acquisition by Bayer, merger between Dow Chemical and DuPont).

In the industrial sector, General Electric (GE) is now also considering a demerger of its company parts in the run up to the flotation of Siemens‘ medical technical activities. Faced with the dramatic plunge in the share price, the new CEO finds himself under due pressure to act. In November, management had already announced a concentration on the core divisions aerospace, energy and healthcare as well as the sale of peripheral activities. Management is currently playing through other options, signalling the possibility of divisions being floated on the stock market. A demerger would probably mark an involuntary turnaround for the company. Since 2013, the industrial conglomerate has been investing around USD 34bn in acquisitions to expand several business areas, and these were often made at an unfavourable time on the market or at an excessive price. In hindsight, the acquisition strategy failed to generate much value for the shareholders. A positive example for a demerger in the industrial sector is the Dutch technology group Philips that has disposed of its traditional lighting business and is now focussed on medical technology.

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