Inside M&A. Financial Services Firms Streamline Their Operations

Essay

Inside M&A. Financial Services Firms Streamline their Operations
During 2005 and 2006, a wave of big financial services firms announced their intentions to spin-off operations that did not seem to fit strategically with their core business. In addition to realigning their strategies, the parent firms noted the favorable tax consequences of a spin-off, the potential improvement in the parent's financial returns, the elimination of conflicts with customers, and the removal of what, for some, had become a management distraction.
American Express announced plans in early 2005 to jettison its financial advisory business through a tax-free spin-off to its shareholders. The firm also noted that it would incur significant restructuring-related expenses just before the spin-off. Such one-time write-offs by the parent are sometimes necessary to "clean up" the balance sheet of the unit to be spun off and unburden the newly formed company's earnings performance. American Express anticipated substantial improvement in future financial returns on assets as it will be eliminating more than $410 billion in assets from its balance sheet that had been generating relatively meager earnings.
Investment bank Morgan Stanley announced in mid-2005 its intent to spin-off its Discover Credit Card operation. While Discover Card generated about one fifth of the firm's pretax profits, Morgan Stanley had been unable to realize significant synergies with its other operations. The move represented an attempt by senior Morgan Stanley management to mute shareholder criticism of the company's lackluster stock performance due to what many viewed had been the firm's excessive diversification.
Similarly, J.P. Morgan Chase announced plans in 2006 to spin off its $13 billion private equity fund, J.P. Morgan Partners. The bank would invest up to $1 billion in a new fund J.P. Morgan Partners plans to open as a successor to the current Global Fund. Because the bank's ownership position would be less than 25 percent, it would be classified as a passive partner. The expectation is that, by jettisoning this operation, the bank would be able to reduce earnings volatility and decrease competition between the bank and large customers when making investments.
-In what ways might the spin-offs harm parent firm shareholders?