Two findings stood out in my recent analysis of almost 30 demergers on ASX since 2000.
The first was that demergers have produced some of the market’s best-performing stocks in recent years. Treasury Wine Estates, The Star Entertainment Group, Sydney Airport, Recall Holdings, Orora and DuluxGroup are examples of star demergers.
The second was that demergers often struggle at the start, before outperforming their parent company and the broader sharemarket a year or two after listing. That is not true of all spin-offs, but there is enough evidence to suggest patience pays off with demergers.
One wonders why more companies do not spin off non-core assets into standalone, independent companies, list them on ASX and give shareholders stock in the new entity. The benefit for parent and “child” companies can be significant.
Large spin-offs have been infrequent on ASX; a few each year despite obvious institutional investor interest in them. Fund managers often prefer spin-offs to Initial Public Offerings (IPOs) because more is known about their assets and they have been subject to ASX listing rules.
Poor information asymmetry is a turn-off with some IPOs. The seller knows a lot more about the company than the buyer, who must rely on a prospectus and sometimes rubbery proforma forecasts. There is a lot more visibility by comparison with spin-offs.
Also, incentives in spin-offs are better aligned between owners. The parent company wants the spin-off to do well, especially if stock is being transferred to its shareholder through an in specie share distribution. Unlike private equity firms that often sell assets when markets peak, the best spin-offs do not try to time market cycles or make quick returns.
Other arguments for spin-offs include the new entity being better able to compete for capital and control its destiny; and management being more motivated as it now leads a standalone listed company, not a division of a giant conglomerate. Analysts, too, are better able to value spin-offs and compare them with peer companies here and offshore.
Two of the latest spin-offs are an opportunity. South32, demerged from BHP Billiton in 2015, struggled after listing in line with the broader resource sector sell-off, but has bounced back in recent months. It has a strong balance sheet, takeover appeal, and is among the higher-quality mining companies. But I’m not convinced it is time to buy resources just yet.
National Australia Bank’s spin-off of its troubled United Kingdom regional banking assets in CYBG Plc is a different story. The demerger came to market cheaply, has performed okay since its Chess Depositary Interests (CDI) traded on ASX, and has good medium-term prospects.
To recap, CYBG, or Clydesdale as it is better known, was a serial underperformer with NAB and a reason why it underperformed the other big Australian banks. It delivered poor return on equity and struggled with ownership uncertainties.
NAB distributed 75 per cent of CYBG (Clydesdale) to its shareholders on the basis of one Clydesdale share for every four NAB shares held, and sold the remaining 25 per cent via an IPO to institutions.
Clydesdale has the makings of a good demerger: an underperforming, neglected business within a conglomerate that has unrelated assets and better prospects as a standalone company. The best demergers usually involve the spin-off of assets that offer few synergies with the parent company and do not naturally sit within it.
A new, revitalised management team has much to work with. CYBG’s underperformance is at odds with a UK retail and commercial banking sector that has been surprisingly profitable in a low interest-rate environment.
The United Kingdom is one of Europe’s better-performing economies and its banking sector has solid growth prospects and is ripe for consolidation. Some good judges I know believe Clydesdale could be a takeover target for a European bank that wants a UK platform build a bigger business in what is a highly concentrated, competitive market.
CYBG wants to lift its adjusted return on tangible equity from about 5 per cent to double digits within five years – an ambitious, though possible target.
That’s an opportunity for Clydesdale’s new management and shareholders. There is significant scope to restructure costs and revenue, and a chunk of the investment has already been made. Demergers sometimes struggle in the short term because they have been badly neglected and new owners need to commit slabs of capital to fix the assets.
CYBG CDIs (its primary listing is in the UK) rallied from a $3.69 issue price in early February to $3.94 – a good effort in a volatile market. A median share-price target of $4.23, on consensus analyst estimates, suggests CYBG is a touch undervalued. Macquarie Wealth Management is at the high end with a $4.75 valuation.
Chart 1: CYBG
Source: The Bull
Investors should watch and wait for better value in CYBG. The odds favour spin-offs underperforming in their first six to 12 months before outperforming. That was true of South32 and it might be true of CYBG, although it arguably has more short-term upside than many demergers given its underperformance within NAB.
Whatever the case, CYBG is one to watch. It has some traits of high-performing demergers and the best spin-offs have handsomely rewarded shareholders over the years.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at March 31, 2016.