Following Sanofi’s January announcement that it will pay $11.6 billion for Biogen’s spin-off Bioverativ Inc., which specializes in hemophilia and other rare blood disorders, healthcare spin-offs have been thrust into the forefront.
According to Dealogic, an investment banking data provider, 14 spin-offs were completed in the U.S. last year, of which two were healthcare: Bioverativ and Varex Imaging Corp.’s spin-off from Varian Medical Systems.
A spinoff occurs when a company, the parent, distributes a subsidiary or an operating division to its shareholders, according to John R. Washlick, shareholder with Buchanan, Ingersoll & Rooney, and a member of its healthcare division. “The distribution is proportionate to the shareholder’s equity interest in the parent,” Washlick says. “One significant benefit to the parent company and its shareholders is that the transaction is generally treated as a tax-free transaction under the Internal Revenue Code.”
Managed Healthcare Executive (MHE) talked with Washlick, who specializes in healthcare system transactions and market consolidation, about healthcare spin-offs, what the trend means for the future of mergers and acquisitions, and what advice he has for healthcare executives.
MHE: What do healthcare spin-offs signal for the industry?
Washlick: Most spin-offs in healthcare occur in the life science space rather than the provider side that is hospitals and health systems. This is because most hospital and health systems are not publicly traded and in fact most are nonprofit, tax-exempt institutions. With the most notable exception in recent years being Community Health System (CHS) when it spun-off Quorum Health Resources in 2016. Quorum Health Resources was a hospital management company that CHS spun-off to its shareholder along with 38 hospitals in 16 states. The result of the spin-off was to permit CHS to concentrate its business efforts in larger markets, while Quorum focused on smaller markets and mostly rural areas with a population less than 50,000. Both Community Health System and Quorum are public companies traded on the stock exchange.
MHE: What should healthcare execs know about spin-offs?
Washlick: While in many cases the parent experiences an uptick in trading value and both companies may experience significant value as a result of the spinoff for up to three years, over time each company must sustain its growth independently and often the value resulting from the spin-off hangover will disappear over time. Therefore, management should not look at a spin-off as some silver bullet to increase its stock value for the long term.
Second, a sale of a subsidiary or business unit will result in a taxable event. A spin-off is tax free.
Third, a spin-off is an opportunity to improve the parent’s balance sheet and income statement if a division has significant debt or is eroding the parent’s profit margin.
Finally, a spin-off does not come about quickly. They can take a couple of years to fully develop so boards and management must be patient and deliberate.
MHE: How will spin-offs reshape future M&A deals?
Washlick: Again, I do not see spin-offs becoming all that common anytime soon with hospital and health system providers because few are publicly traded. However, the trend should continue in the life science space. Where the saying, “the whole is greater than its individual parts” may be true in most cases, companies may take a second look before they enter into any M&A negotiations to determine if the inverse may be true, that is “the individual parts are greater than the whole.” If so, board may spin off certain subsidiaries or operating units before an M&A transaction so they will survive independently post transaction.
MHE: Why would a company consider a spin-off?
Washlick: There are a number or reasons a company may consider a spin-off. First, the parent and division/sub may be two distinct types of business, for instance pharmaceutical manufacturer and a consumer healthcare division, like Pfizer. A spin-off allows each corporation and its management to focus on its core business activities, including building the right management team with the appropriate niche and expertise specific to each company’s business model, addressing capital needs, and identifying market expansion and targeting market opportunities. When bundled under one enterprise, management resources may get stretched and diluted; unintentionally neglecting one side of the business for lacking the management expertise to take a particular division to the next level. Second, there is always a buzz when there is a spin-off, or even a rumor of one. This excitement often results in a bump in the parent’s stock price and attracts potential new investors to both the parent company and the spun-off company.
MHE: What is your top advice for healthcare executives looking to do a spin-off?
Washlick: First, review operations and subsidiary activities to determine if a spin-off makes sense versus an outright sale. Whereas a sale might bring needed cash to an organization’s operations, a spin-off may yield greater returns down the road. Second, will the spun-off company have the right management team out of the starting blocks or will a new management team with skills unique to the business core off the spun-off company need to be recruited? If so, that will require significant time and resources to complete before any public announcement of a potential spin-off. Finally, will the spin-off result in both companies being better situated to position themselves to take advantage of market opportunities, separately?