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South32 Ltd: Don’t miss opportunities by missing spin offs

Spin offs often turn out to be worthwhile investments and can be overlooked by investors and institutions.

Investors often get sent a few shares or a cash dividend in the spin-off company and don’t take too much notice. But these companies can often prove to be great investments.

A company may spin off a segment or division that is considered non-core as it does not fit into the portfolio of assets the company currently owns, or because the non-core assets are not getting the attention they require. This means management may not be prepared to commit the capital necessary to improve them.

Another reason may be that management may not believe it could access the capital necessary to improve these assets under the current structure.

When looking at divestments you can analyse the original operation in the current structure before they are spun off, so the whole process is very transparent. Check insider buying to see what the managers of the new company think about its prospects.

Large parent companies do not want to spin-off divisions and see them get into trouble, as that would reflect badly on them, so they usually have strong balance sheets and are prepared to succeed on their own accord and the management of a company must believe the divestment will add value, otherwise they would not recommend it.

South32 Ltd (ASX: S32) is an example of a recent high profile spin off that has done well and is up 50% since listing in May 2015.

The company was divested by BHP Billiton Limited (ASX: BHP) as it was taking up a disproportionate amount of management time within BHP with 10 per cent of BHP’s assets taking up 40 to 50 per cent of management time.

The company was spun off with a strong balance sheet and low debt. Had the company collapsed with the downturn in commodity prices soon after listing, due to high debt levels, this would have reflected badly on BHP management.

Sydney Airport Holdings Pty Ltd (ASX: SYD) was spun off by Macquarie Group Ltd (ASX: MQG) in November 2013 and has almost doubled in price since then. Macquarie used the sale to enhance its return on equity and increase capital for further early stage investments.

So the next time you are sent some shares in the spin-off or hear of one, some further investigation could prove valuable.

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Based on the last 12-months of dividends, its shares are currently offering a fully-franked 4.8% yield, which grosses up to almost 7% when those franking credits are included.

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Motley Fool contributor Christopher Coe has no financial position in the shares mentioned above. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson

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