Demergers

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Reasons for Demergers

A demerger is the reversal of a merger between two firms or the reversal of a takeover. One large firm is broken into two or more smaller firms. This can happen because of:

Diseconomies of scale

If the firm is too large and is experiencing diseconomies of scale then a firm may decide that a demerger is better for shareholders.

Antitrust

Like how governments block some takeovers, a firm may demerge because of government intervention.
If a government views a monopoly market structure as a market failure, then the government may force the firm to be broken up.
Standard Oil was split up by the US Supreme Court into multiple smaller oil companies in 1911.

Failed merger

If firms merged hoping to cross-sell extra products to customers and this failed then they may demerge.
If firms merged to try to cut costs by sharing some costs, but this failed, then they may demerge.

Underperforming business unit

If only one part of the business area is underperforming then it may make sense to demerge that part of the business so that management can focus more on the more successful business areas or units.
Equity markets may increase the 'multiple' that investors will pay for a business if it only contains 1 successful business instead of 1 successful business and 3 underperforming businesses. Therefore a demerger could create shareholder value.
Philips sold off their Philips Lighting business via an IPO to focus on higher margin businesses.

Investment or debt

A firm may sell off one of its divisions to pay off business debts or to undertake a major investment programme.
Hewlett Packard separated their software and hardware businesses in 2017.

The Impact of Demergers

Demergers can have different impacts on businesses, workers and consumers.

Impact on businesses

A business is likely to have a better focus after a demerger.
The total equity value of the business units may rise after a de-merger. If the businesses were unrelated, then a 'conglomerate discount' may vanish.
If a business was suffering from diseconomies of scale, then a demerger may increase efficiency and lower average cost. However, if the business was operating at the minimum efficient scale, then a lower output may increase average cost.
Selling a loss-making business is difficult. People are more likely to want to buy a successful business. 'Realising a loss' on a past acquisition and accepting it was a bad choice may harm management's power in the business.

Impact on workers

Some workers may be forced to work for a new legal entity or employer. There may be cultural clashes or a fall in morale.
If the demerger happens to fund investment, then some of this investment may be in machinery or automation tools that reduce the need for labour.
Operating in a smaller firm may be good for workers. Dunbar's number finds that people can operate in groups of up to 150 whilst maintaining strong social relations with all of the other members of the group.

Impact on consumers

If demerging stops a firm suffering from diseconomies of scale, efficiency could rise, costs could fall and prices could also fall, increasing the level of consumer surplus.
But if the firm loses economies of scale, costs could rise and prices could rise. This is likely to reduce consumer surplus and consumer welfare.
But having more firms in an industry may increase choice and competition, leading to higher quality products/services and lower prices.