EnCana is one of the largest oil and gas companies in the world which, at oil and gas prices being what they are, also makes it one of the largest companies in the world (Forbes Magazine ranks it as one of the 200 best companies in the world). On Sunday, EnCana announced it would split itself into two different companies. For lack of a better term, EnCana Gasco (which will hold all its natural gas properties and assets) and EnCana IntegratedOilco (which will hold all of its oil properties and assets including those in the Alberta oilsands). The market reacted favorably to the move, sending EnCana stock up more than 8% in a day (this is not a recommendation to buy). EnCana is not the first company to split itself up into parts: Altria spun out Philip Morris recently and Canadian Pacific Limited spun itself out into 5 subsidiaries in 2001. Why do companies do this and is this good for the investor?

1. Wall Street is much stupider than you think.  The financial industry loves simplicity. Most analysts have never run a business before. Many take their newly minted MBA to a big investment bank so they don’t understand the day to day of running a business. They only look at numbers and businesses with lots of different operations confuse them. EnCana confused analysts because they had natural gas production and oil production and, despite the fact they are both energy plays, it left the street confused (insert your own observations here). Thus, EnCana splitting itself into two companies that concentrate on one thing only feeds the street’s need for simplicity.  For the investor, this is good too because you invest in businesses which is easy to comprehend and simple to understand businesses send stock prices soaring. On the other hand, complicated businesses suffer from the dreaded “conglomerate discount” where the analysts get confused and throw their hands up in the air and punish the stock (see General Electric as a prime example or even Citibank pre-subprime where critics complained that it had become too unwieldy of a financial services empire and difficult to understand- well, they solved that problem didn’t they?).
2. The upside of the company just doubled. Every shareholder of EnCana currently will receive one share each in each company and the current dividend will be split such that the shareholder is going to receive the same amount of dividend but now paid by two entities. Thus, the investor has twice the opportunity for the stock price to go up. For the companies and investment community, any company that gets split up into smaller parts makes it easier for it to be taken over (think of a cake; it is easier to eat two medium sized slices than one big one. Same logic applies to a company a competitor wants to buy) which equals $$$ for advisors in a take-over situation and a greater return for the investor of the company being acquired.
3. You can always make a quick buck. Companies that split themselves up only do so after lobbying from the investment industry (see above for the reasons why). When they do listen to the investment industry, the stock typically shoots up quite quickly (although not always the case) so it presents an opportunity for a shareholder to cash out quickly once the company announces it is splitting up.

Companies that split themselves up do not always present a winning situation for investors but, because of magnitude of the move, most companies only undertake this if they know the outcome will be generally positive for all. However, there are always exceptions to the rules: some companies split up after a disastrous merger (for years, shareholders have demanded that AOL Time Warner break itself up after one of the worse corporate mergers in history). But, even in these circumstances, the stock tends to head up after the announcement (although the gain is relative considering the stock price probably crashed).

As an observation about the cyclical nature of business (or the fickleness of the business community), EnCana is actually the product of a merger as recent as 2002. One of the primary reasons for the merger was to satisfy the investment communities’ desire to create an energy company sufficiently big to be competitive globally- and now its too big for the same community to comprehend. Go figure. Same thing happened to AT & T: it is almost back together from its Ma Bell days (although they were forced to break themselves up).  Having a lot of degrees does not guarantee you’ll be just as indecisive as the rest of us.