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Corporate slicing and dicing will not necessarily resolve deep-rooted problems

It took Germany‘s struggling lender Deutsche Bank and what remains of retail group Metro to show investors that spin-offs and demergers are not the panacea they looked like for a long time.

Deal-hungry investment bankers and pesky activist investors have for years badgered the top brass of clunky and complex German corporates to shrink themselves to greatness. And for several years a string of successful demergers proved their point, leading to sharper managerial focus and better operating performance.

For investors there was a welcome fading of the “conglomerate discount” that had hung over the valuations of the parent companies and the opportunity to diversify into the businesses that had been spun off.

Take Osram, the lighting unit spun out of Siemens in 2013. A capital intensive business in an industry disrupted by the rise of LED technology, Osram’s shares surged almost 50 per cent in its first year as a standalone company, outperforming its former parent and the wider German stock market.

Two years later, the share price of Covestro, the plastics unit of German chemicals company Bayer, doubled within its first year as an independent company, trouncing Bayer’s performance. This year Siemens has repeated the trick, with its healthcare unit Healthineers, listed in the spring, outshining its parent and Germany’s benchmark index, the Dax, which has fallen 15.8 per cent.

But this year has also inflicted damage on the conventional wisdom that spin-offs and demergers are an infalliable route to higher share prices.

DWS, the asset management business of German lender Deutsche Bank, is perhaps the most striking example. The listing in March of a minority stake in DWS was one of the few turnround projects Deutsche delivered on time. But the hope that DWS could decouple itself from its crisis-prone parent has proved an illusion — the stock of both have moved in close sync downwards. In July, DWS chief executive Nicolas Moreau admitted that “the noise around the bank” had “some impact” on the asset manager’s performance. Three months later, he was out of a job.

German retail conglomerate Metro has been engulfed in a slow-motion and disappointing break-up under chief executive Olaf Koch. Ceconomy, the electronics retailer Metro sput out in 2017, issued a string of profit warnings over this summer that triggered the departure of its chief executive and finance director. Metro’s remaining wholesale business is suffering from sluggish growth in its home market Germany, headwinds in Russia and unimpressive profitability.

Metro’s largest shareholder, the Haniel family, has lost its patience and after more than five decades is in the process of offloading its stake. Mr Koch’s announcement in September that it plans to find a buyer for its supermarket chain, Real, in order to focus on its wholesale business was welcomed by analysts but failed to ignite Metro’s share price. Shares of Metro have fallen by about a quarter since Ceconomy was spun off in the summer of 2017, while the the latter’s are down by about half.

There are specific reasons for the struggles of DWS and the various efforts by Metro. Deutsche Bank chose an unattractive governance structure for DWS that gives external shareholders limited influence, picked an outside chief executive who failed to galvanise employees and promoted unrealistic targets. The asset management industry is also suffering from the rise of passive investment products, which are far less lucrative.

Both Metro and Ceconomy operate in brick-and-mortar retail, a sector that the internet has disrupted.

Yet there is a wider point to be taken from the travails of Deutsche’s DWS and the businesses Metro has offloaded. Both show that “spin-off and demergers are not a means in themselves,” says a senior Frankfurt-based investment banker, adding that some boards are trying to use them as an easy fix to deeply rooted problems that would be better addressed by an operational restructuring. That is something that companies — and, indeed, investors — accustomed to the historic success of demergers may struggle to adjust to.

And there are few signs so far that this year’s disappointments have sapped corporate Germany’s appetite for demergers. Volkswagen and Daimler are both working on a potential carve out of their trucks units, automotive supplier Continental is preparing the split of its powertrain unit and ThyssenKrupp is planning to split itself into a capital goods and a materials company.

This blitz of corporate slicing and dicing will keep investment bankers busy. However, shareholders should be asking tougher questions before giving them the green light.