What is a business spin-off?
A corporate spin-off occurs when a firm 'splits off' a section of the company to become a separate business. There are a number of reasons that this could take place, including:
- Allowing the parent company to focus on its core business and being free from a distraction in a different industry. This takes place particularly if companies have multiple business divisions.
- Splitting high growth businesses from low growth ones.
- Allowing a new environment for creative ideas to be fostered and exploited, away from the parent company.
Following a company spinoff, what happens is that shareholders of the parent company receive equivalent shares in the new company. Shareholders are then free to buy and sell stocks from each company independently. This puts original shareholders in a tricky position and provides significant opportunity. Let see why:
- Most shareholders, who purchased the stock, did so as a result of the appeal of the parent company. They are therefore far more likely to sell their 'new' holdings.
- The valuation of the firms may be significantly impacted, which may revise the true value of the holdings significantly up or down. A number of shareholders may be unaware of this and unable to correctly value their shares.
- Institutional holders may find that their newly acquired shares do not meet their portfolio's 'requirements'. This is particularly true for pension funds that are required to hold firms of a certain market capitalisation. They may be forced to sell putting undue downward pressure on the spin off's shares.
Opportunity awaits
Intelligent investors who are able to accurately value businesses can profit from this inefficiency. In fact, spinoffs have been shown to significantly outperform the stock market. New managers are highly incentivised to perform, as they are granted share options and paid based on their performance. There are a number of crucial factors to successfully help you profit from spin-offs
- Understanding of valuation and the economics of both/one of the companies.
- Patience to ride out the volatility which often occurs as a result of spinoffs.
- Carefully selecting only the highest quality spinoffs.
Examples of Successful Spin-Offs
Mondelez
Kraft Foods spun off its $36 billion global snack foods division into Mondelez. The new internationally-focused company has powerhouse brands like as Oreos, Ritz, and Trident. The remaining company was renamed Kraft Foods Group and sells grocery brands such as Oscar Meyer, Nabisco, and Planters.
Since the spinoff, Heinz and Mondelez have significantly grown their earnings and both of their stock prices have performed well.
American Express
In 1994 American Express spun-off Lehman Brothers, which had been dragging down its profits, to concentrate on its core credit card business. American Express a share of Lehman's profits. However, Lehman's poor performance continued and in 2008 the company collapsed, in what was the beginning of the global financial crisis, while American Express continues to flourish.
On your quest for profits, be sure to check out some upcoming spin-offs in the Australian Market
