Corporations are going all out to boost their share prices, often at the behest of activist investors. And one method they are using to raise valuations is spin-offs.
The idea behind spin-offs is that the sum of the parts is worth more than the whole. “Companies that are in multiple businesses have created shareholder value by executing spin-offs,” says Scott Bok, CEO of New York–based investment bank Greenhill & Co. A spin-off frequently occurs when a company has business units with different growth characteristics. One may be a high-growth, low-cash-generating business, whereas another may be the reverse. “They should have different capital structures and dividend policies, different acquisition strategies,” Bok continues. “That’s when it makes sense to split in two.”
Based on their market capitalization after the first day of trading, the value of spin-offs so far this year stands at $102.4 billion, more than double the $48.4 billion for the same period of 2014, according to financial data provider Dealogic. The biggest such deal so far has been eBay’s $49.2 billion spin-off in July of PayPal Holdings. Other major spin-offs this year include the $17.2 billion separation of pharmaceuticals company Baxalta from Baxter International. The new company is already fielding a $30 billion takeover attempt from Ireland-headquartered pharmaceuticals company Shire.
Another reason for corporations to split off divisions into separate companies is that spin-offs may provide peace of mind. For companies whose earnings are struggling, spin-offs can “create a calmness for shareholders” if it’s a company whose units don’t have synergies, says Jonathan Morgan, London-based deals analyst and head of research at Edge Consulting Group, an equity research firm focusing on spin-offs.
At the same time, though, shares of spin-offs may fall off analysts’ radar screens, given their unfamiliarity with the new stocks. Many existing shareholders often aren’t interested in having a stake in the new company. As they sell their shares, they push the stock price down, which creates an opportunity for new investors to buy in at what may be a bargain price, says Jack Ablin, chief investment officer at BMO Private Bank in Chicago.
Stocks of U.S. companies that have been spun off this year have declined 7.9 percent on average through July 31, according to Edge Consulting.
A Bank of America Merrill Lynch study of spin-offs from 2000 to 2013 found that in all but two of those years corporations announcing spin-offs outperformed the S&P 500 index by 9 percent on average. As for the companies spun off, they generated a return of more than ten times the gain of the MSCI World index over their first 12 months of independence, according to a study of global data since January 2000 by Edge Consulting and Deloitte. The share prices of spin-offs frequently struggle for three or four months and then appreciate “as the spun-off companies develop an operating history,” says Charles Ryan, a portfolio manager at Evercore Wealth Management, a $14 billion asset management firm in New York.
So what makes for a successful spin-off? Says Morgan: a strong management team and management compensation packages that are tied to corporate performance, such as profits and stock price. It’s also important to avoid loading down the spin-off with debt. For example, DuPont stuck the Chemours Co. with a $4 billion debt burden in a $3 billion spin-off on July 1. Chemours’s stock price has since sunk by roughly one third. Of course, if it is to flourish, the spun-off company must be also a high-quality business. “Is the company just being spun off because it’s a rubbish business, or do they believe the long-term management can improve things?” Morgan asks.
Companies that wait at least six months after announcing their spin-offs to execute them produce a 50 percent greater return for the spin-offs than those that don’t, according to the Edge Consulting–Deloitte report.
It might seem paradoxical that spin-offs are proliferating at the same time as mergers and acquisitions, but it makes sense, Ablin says. Mergers are happening where businesses are aligned, and in instances where they aren’t — corporations are spinning off those disjointed businesses. Most experts anticipate the spin-off trend will continue, though Morgan says it may ebb by 2017, as company executives find they can easily sell their divisions or entire companies to other corporations flush with cash.
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