The pace at which competition has forced restructurings in almost every industry has boosted the volume of corporate spin-offs.
Spin-offs provide fertile ground for a variety of investment disciplines. Growth opportunities arise when a mature company divests a subsidiary whose prospects have been masked by the slow growth of the parent. Value investors benefit when the price of a seasoned business — new to the public market — is beat down to attractive levels due to indiscriminate selling. Academic studies consistently confirm that the average spin-off has outperformed the market within three years of independence.
Spin-offs occur when a parent corporation distributes all or most of its ownership in a subsidiary to the parent’s shareholders on a pro-rata basis. As a result, the subsidiary company is no longer owned or controlled by the parent company and there are two separate publicly traded companies. This transaction is considered a stock dividend and is tax-free.
It is important to distinguish tax-free spin-offs from other types of related transactions (such as IPO carve-outs and corporate split-offs). Under an IPO carve out, a portion of the subsidiary’s shares is offered for sale to the general public. When the IPO market is healthy and valuations robust, some companies choose to carve out a subsidiary to boost shareholder value. IPO carve-outs can often be the first step of a tax-free spin-off. For example, the parent may first sell 20% of the subsidiary to the public in an IPO. The parent could then later distribute the 80% that it still owns in a tax-free distribution.
Under a split-off, shareholders exchange their parent stock for shares of the subsidiary. Split-offs also provide the parent an opportunity to separate the subsidiary in a tax-free manner.
Case for spin-offs
The first and foremost reason to invest in spin-offs is, of course, to make money. The idea of getting smaller may seem counterintuitive, but corporate spin-offs can be a very attractive option for companies and their shareholders. The rational behind a spin-off or a carve out (partial IPO) is that the parts are greater than the whole. A spin-off can help improve a company’s valuation by providing powerful incentives to the people who work in the spun unit. Further, a split can help the parent’s management to focus on the core operations. A spin-off often reduces the internal competition for corporate funds. For employees in the new separate entity, there is publicly traded stock to motivate and reward via stock and options. Spin-offs often result in a higher aggregate value for the constituent pieces. When one reconstitutes the parent and the spin-off after a one- to two-year period, overall outperformance is often observed.
340% + in the last 10 years
The Bloomberg U.S. Spin-Off Index (BNSPIN) is a market capitalization-weighted index that contains stocks with $1 billion in initial market cap that were spun-off from U.S. companies. The index includes companies from spin-off, split-off and carved out activities. We view the Spin Index as a good proxy for how spin-offs in general are performing. The BNSPIN has crushed the S&P 500. The Spin Index is up 6.85% year-to-date (as of March 7) versus a 2% return for the S&P 500. During the past 12 months the Spin Index has returned 37.5% versus 17% for the market. For the 10-year period, the BNSPIN has appreciated 342% (154% for the S&P 500 Index). The Guggenheim S&P Spin-Off ETF (CSD) tracks the S&P U.S. Spin-Off Index, and has produced similar returns (see “Spinning profits,” above).
It appears that 2018 will be a banner year for spin-offs. In the first two months of 2018, there has been 11 new spin-offs announced (versus three spins announced year-over-year through February).
