A spin-off, as is well known, is the separation of a subsidiary from the parent company by a distribution of shares as dividends to shareholders of the parent company, or, alternatively, by selling shares to the public in an IPO. In both cases, it means the spin-off company changing from a private company into a public one, whose shares are traded on the stock exchange, similar to the common IPO process.
In his excellent book, “You can be a stock market genius”, Joel Greenblatt explains the main points that must be examined when looking at spin-off shares in a simple manner, and also presents a number of case studies in which he has invested. This is an excellent book that could open the door for investors who wish to enter the field. But still, since any spinoff needs to be analyzed and evaluate in depth, it is necessary to carefully study the entire picture as it appears in the prospectus that is published by the parent company prior to the separation. In the case of US companies, the prospectus published to the US Securities and Exchange Commission (SEC) is called a 10-12B form.
Similar to the financial reports of public companies, the separation document opens with a description of its activity – what products or services it provides, who are its customers, and who are the major competitors. The company’s financial statements from several years back are then presented, with the addition of pro forma statements, which are supposed to reflect what the current financial report of the company will be, once it is independent. This is the major financial data with which it is possible to assess the potential of the company, the financial risk inherent in its activities, and of course, the fair price of its shares.
Another point worth giving a focus to is who the managers of the spin-off are, and what is their compensation plan. In many cases, senior officials from the parent company move on to manage the spin-off company, whose activity is often significantly smaller compared to that of the parent company. Why would the CEO of a major company give up a central role and a high salary and move on to manage a small, anonymous company? There is only one reason for this: He believes he could turn the small company into a large one, and receive a notable financial reward for it. A specification regarding the compensation policy can be found in the separation document.
It is important to note that the separation document, as is the case with the IPO prospectus, is not a simple document – usually is deals with an unfamiliar, small company, with limited financial data, so the analysis of a spin-off requires not only knowledge of reading financial statements, but expertise dedicated to the field. This is the reason only a few investors look at spin-off companies that are just starting out, causing them to be traded too low. Investors who do choose to examine the spin-offs, can detect that pricing distortion and earn big when the shares return to their fair price.
Additional spin-off articles
Spin-off investing is an undiscovered field for most investors. Still, there are many articles and researches that were written about it during the years. The following list of articles can be used to further understand the mechanism of spinoffs and the reason for their excess return above the market.
“Spun-off entities initially underperformed their industry peers but in the long run generated superior returns after the spinoff. Carved-out subsidiaries experienced a large jump in stock price on the first day of trading, but long-term performance is not particularly attractive”
An excellent introduction to all kinds of spinoffs, including cure-outs, IPOs, and various combinations.
“None of these tasks is easy, but getting them right will likely be the difference between a spin-off that creates superior value and one that does not. As the corporate transaction market continues to heat up, spin-offs are likely to become even more popular.”
“Investing around spinoffs has proven highly profitable for bargain-hunting investors – and will likely remain so, despite so many being in on the secret.”
The Stock Price Performance of Spin-Off Subsidiaries, Their Parents, and the Spin-Off ETF, 2001-2013 (MCCONNELL, SIBLEY & XU ), 2015
“Beginning in 1965 and ending in 2000, the evidence suggested that a strategy of investing in the spun-off subsidiaries and holding the shares for 22 months, while concurrently buying and holding the parents’ shares for 15 months,Â would have yielded superior returns relative to risk-adjustedÂ benchmarks. We address the question of whether such a strategy would have yielded superior returns over the subsequent 13 years, from 2000 to 2013. It would have. More specifically, spun-off subsidiaries beat a size and book-to-market benchmark by a cumulative buy=and-hold return of 17.1% over 22 months; parents beat the benchmark by a modest 3.7% over 15 months. In this instance, history did repeat itself.”
“Despite investor pressuresÂ for more spin-off activity, boards and management teams, in conjunction with their financial advisors, should continue to consider both the short-term and long-term value benefits of separations.”
“The analysis shows that Spinoff companies performed better than Parent companies a year after the demerger on average, seeing an 8% higher average return.”
“Divestitures not only bring internal improvements for companies; they also reward investors. The biggest benefits accrue to those who get both the strategy and the execution right.”
“I found that the optimal investment period for low degree of relation spinoffs is the 365 days starting with the first day of trading, yielding a positive abnormal return of 36.5%.”
“We examine the performance of firms involved in spin-offs over the past 17 years. We find that spin-offs lead to price appreciation for parent companies and their spun-off children. We note that investment timing is important in the short term and that the volatility of returns is significant.”
“We believe that many recently spun-off companies as well as companies spun off 16–18 months ago provide attractive investment opportunities.”
An introduction to spinoffs and an explanation of the motivation for the separation.
“In this paper, we examine in detail stock price performance of spinoffs and their parents on a comprehensive sample that covers the last 36 years. We show that excess returns are indeed positive for both subsidiary and parent companies over almost all holding periods considered.”
“Companies that restructure their ownership can often improve the performance of business units by exposing them to the market and thus attracting a more focused analyst community and new investors… spin-offs, equity carve-outs, and tracking stocks are important tools that help corporate management increase value.”
“The relative returns of spin-offs were found to be even higher than in previous studies, and the diversification benefits, as measured by the correlation with the S&P 500 Index, were equally dramatic.”
“We find significantly positive abnormal returns for spinoffs, their parents, and the spinoff-parent combination.”