Impact Of A Demerger On Fiat Industrial Group And Diversification Strategies, Essay.

Background - Demerger of Fiat Group

The Fiat Group witnessed a demerger in the year 2010, to lead the company's to a better financial position. The demerger included the formation of the Fiat Industrial. The Fiat Group before the demerger comprised of several firms which produced a variety of goods. For example the group produced commodities ranging from automobiles, construction and agricultural equipment, vehicles used in the industrial sector along with production of machineries used for production and component systems. Hence we find here that these products are diverse and they also range between product type and usage. As such the Fiat Group was huge having many subsidiaries operating under one parent organisation, this led to difficulty in realisation of a single product to the most efficient scale. Within an industrial conglomerate, each product had its own characteristics which are never given an opportunity to develop on its own (Dasilas and Leventis 2018). The spinoff or demerger was important because it would lead the market to realise the potential of each product or product group. Another very important reason for the demerger was that it would lead the organisation heads to focus on a single product or single business rather than the whole industrial unit (Bidault and Castello 2010). The impact of the de merger of Fiat industrial group result increase of share value by about 9%. According to the CEO March demerger would allow the auto business and industrial components business to generate a revenue of over 64 billion Euros in 2014 along with contributions made by the US partner Chrysler. The new Fiat was expected to generate a trading profit of about 3.8 bn Euros in 2014. While the Fiat industrial expected to produce 29 bn euro revenues with a similar trading profit. The demerger hence allowed the Fiat group to have a better vision of its goals and also in essence make competition possible on those specific product groups. The group was also able to split their industrial debts between the two broad product groups (Reuters 2010). 

Any big industrial group might look to focus on one section of the business and they might want to allow for divesting their assets. The main options that can be available to the industrial groups like Fiat are split-off or curve out apart from spin-off. Here we find that the Fiat group actually opted for a spinoff. For a split-off the decision making lies on the shareholders. In a split off the leaders of the organizations offers their shareholder the shares of a new subsidiary but shareholders can decide to hold the shares of either the parent corporation or the subsidiary. In a split off the shareholders can choose to remain in the parent organisation or the become part of the subsidiary, distribution of the shares are not equally distributed. Within a split off the business can be restructured thoroughly, by offering incentives to their shareholders who might not be willing to participate in the split off. One benefit of split off is that since only shares are traded between shareholders the parent company can induce into a tax free venture through a split off (Pham, Nguyen and Adhikari 2018). 

Impact of Demerger on Fiat Industrial Group

If Fiat Group opted for a split off they could have gotten rid of the debts and risky assets of the subsidiary which were making losses. Furthermore the cost of agency required in a spinoff could have been avoided by Fiat Group through a split off. A split off is far more advantageous when it comes to increasing the profitability. Since a complete restructuring occurs the parent and the subsidiary companies have bigger options to rationalise workforce or divide labour, allocation of capital optimally and also increasing the strategies on one part. (van Gampelaere  2019.) 

A carve out on the other hand means that the parent organisation is selling on portion of the shares of a subsidiary to the public. Meaning having the opportunity to raise funds from general public known as the initial public offering (IPO). For an IPO to be successful, only 20% of the shares can be given to general public and 80% of the shares would be held by the parent organisation. In essence the a carve out also creates a net set of shareholders within the subsidiary corporation. One important benefit of the carve out process is that it allows the parent organisation to capitalise those subsidiaries which are performing well and also are not part of the core operations of the organisation (Wiebe 2018). 

A major part of business and being serious about it, no matter the choice of asset, involves diversifying My Portfolio so as to improve the overall odds of making profits as well as mitigating any risk of losses. Diversification strategies have several pros as well as cons that are attached to them and are referred to frequently in the business and trading world. Although the pros typically outweigh all the cons of diversification that too in a significantly large margin, it does not necessarily mean that there are no significant drawbacks to the strategies of diversification. Therefore, the purpose of this answer is to provide a critical reflection on the various pros and cons that are associated with diversification strategies.

Pros

Leveling out the risk and volatility: Probably the most obvious pros of a diversified portfolio is leveling out the trading and business risks and volatility. If and when the market falls or moves downward, there is a significant risk of the entire portfolio going down with it but the risk can be significantly altered if I have investments in various asset types to balance the business and trade (Mikheeva 2017). In this way, I will be able to make profits on a single asset while the other assets are stagnating in the market crisis.

A broad overview of diverse markets: By deploying a diversification strategy I would need to pay some attention to several markets in which the diversification assets are tied in comparison to fewer assets (Burlacu, Gutu and Matei 2018). This process automatically leads to an improved understanding of the markets that in turn can help me to take better and more informed decisions later on.

Diversification strategies also provide the opportunities to dive down beyond the ordinary geographical restrictions: As the entire global market keeps on fluctuating some regions may experience stagnation while others may enjoy economic booms (Hung and Hager 2019). Diversification strategies allow for a great way so as to participate in market booms by diversifying the horizons that too investment-wise.

Comparison of Demerger Options - Split-off, Carve Out, Spin-off

Cons

The costs of transaction may add up significantly: If and when a company is too diversified, they lose the ability to manage cost-wise and transaction costs for creating the portfolio tends to rise up slowly (Chod, Trichakis and Tsoukalas 2019). The upkeep costs of the portfolio can rise up by a lot and become too much to handle for me later on. A diversified portfolio will require frequent checks and evaluations on the transactional value and costs.

Keeping up with a diversified portfolio can be extremely exhausting: Diversification strategies tend to include a vast array of market knowledge and research that needs to be correctly analyzed so as to take necessary and informed decisions. Keeping up with all this data and their analysis can be exhausting on top of the everyday workload (Itami et al. 2019). Energy levels are also significantly affected due to keeping up with the diversified portfolio. A diversified portfolio would also mean that I would have to look into several sectors in search of properly managing the assets.

The returns from the diversification strategies are potentially diminished: Over-diversification often leads to diminishing returns as profits cannot be easily attained in such a case. It is necessary to take careful risks not having much in the market can be gainful.

One of the major reasons for offering the diversification discount for Fiat is its strategy of spinning off its business units. Among the two major business units of Fiat, the automobiles department is the major revenue-generating unit compared to their capital goods unit. In this case, the best strategy to fit in for Fiat is to diversify their shareholding as well to the maximum number of shareholders for their lower revenue-generating units. Offering diversification discounts refers to the process of selling the shares of diversified firms at discounts (smith and Coy 2018). This refers to the fact that the more will be the diversification of the shares, the more will be the risk segregation for the diversified firms as well as a higher level of cash flows. In the case of fiat, it was important for the management to channel the resources as well as cash flow between the higher and lower revenue-generating units. It can also be concluded that fiat is affected due to over diversifying their businesses and poor management of a multi diversified business. This is due to the fact that the success achieved by fiat in their global automobile business cannot get replicated in their capital goods business. Hence, it was inevitable for them to get penalized by lowering the multiplier for their earnings, which ultimately led to the diversification discounts (Fuente and Velasco 2020)

It should also be noted that due to the initiation of diversification discounts, fiat is getting an effective allocation of financial resources. This is due to the reason that with the diversification discounts, the share price got lowered and got more attractive to the investors, which ultimately led to a maximum inflow of finance to the firm. Hence, this is another possible reason for fiat for diversification discount to leverage the value of higher revenue-generating units for making up for the lower revenue-generating units. Another possible reason for diversification discounts for fiat is the decentralized management structure. This refers to the fact that fiat is having separate management entities for their respective business units with a dedicated organizational structure (Jadiyappa, Saikia and Parikh 2019). Now, in case of generating higher revenue by the automobile department for fiat, the management of the automobile department is eligible for better financial benefits and incentives. This can be a de-motivating factor for the management from other business units. In this case, the self-interest of the management is getting focused, and to overcome this, discounting the diversified shares is the best-taken policy for fiat in mobilizing their internal cash flow.

Pros and Cons of Diversification Strategies

The overall business focus and objective of fiat can also be another possible reason for diversification discounts. This is due to the reason that with the major focus of the fiat management being on the automobile sector, the other units including the capital goods unit are poorly managed, which caused lower revenue and ultimately discounted share prices. Therefore, it can be concluded that there are multiple reasons identified for explaining the diversification discounts of fiat.

However, there are a few steps or approaches that should be initiated by fiat in order to overcome the challenges of diversification discounts. One of the leading approaches will be cross-selling and service bundling. It is recommended that fiat management should bundle the offerings of their automobile and capital goods department (Lee and Hooy 2018). For example, offering financial services from the capital goods department in buying automobiles can help in enhancing the brand equity as well as exposure to the market. Moreover, it can properly leverage the market value of the higher revenue-generating unit in overcoming the issues in diversified business. Cross-selling can also help fiat in generating awareness about their capital goods department by targeting the same market segment of the automobile department.

Reference List

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Chod, J., Trichakis, N. and Tsoukalas, G., 2019. Supplier diversification under buyer risk. Management Science, 65(7), pp.3150-3173.

Dasilas, A. and Leventis, S., 2018. The performance of European equity carve-outs. Journal of Financial Stability, 34, pp.121-135.

de la Fuente, G. and Velasco, P., 2020. Capital structure and corporate diversification: is debt a panacea for the diversification discount?. Journal of Banking & Finance, 111, p.105728.

Hung, C. and Hager, M.A., 2019. The impact of revenue diversification on nonprofit financial health: A meta-analysis. Nonprofit and voluntary sector quarterly, 48(1), pp.5-27.

Itami, H., Kagona, T., Yoshihara, H. and Sakuma, A., 2019. Diversification strategies and economic performance. In The Anatomy of Japanese Business (pp. 319-351). Routledge.

Jadiyappa, N., Saikia, N. and Parikh, B., 2019. Does debt diversification lead to a discount in firm value?. Applied Finance Letters, 8, pp.24-30.

Lee, K.T. and Hooy, C.W., 2018. Can informal corporate governance mechanisms mitigate diversification discount? Evidence from Malaysia. International Journal of Managerial Finance.

Mikheeva, N.N., 2017. Diversification of regional economic structure as growth strategy: Pros and cons. Regional research of Russia, 7(4), pp.303-310.

Pham, D., Nguyen, T. and Adhikari, H., 2018. Determinants of divestiture methods for US firms: asset sell-off versus equity carve-out. Review of Accounting and Finance.

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van Gampelaere, C., 2019. Restructuring & Divestitures. In Mergers and Acquisitions: A Practitioner’s Guide to Successful Deals (pp. 379-408).

Wiebe, Z., 2018. Carve-Out Earnings Quality in Corporate Spinoffs. Available at SSRN 3215341.

Winterbottom, J. and Massy-Beresford, H., 2010. Fiat to demerge autos, industrial activities. [online] Reuters. Available at: <https://www.reuters.com/article/retire-us-autos-idUSTRE63K1P620100421https://www.reuters.com/article/retire-us-autos-idUSTRE63K1P620100421> [Accessed 5 April 2022].