Spinoff Advisors; Points to Consider; Source: Joseph W. Cornell, CFA
spinoffadvisors.com
Points To Consider:
Spin-off pricing inefficiency, where it can be accurately identified, holds the potential for above average investment returns over time. Nevertheless, factors such as timing of the initial purchase, length of the holding period, and selectivity are critical to successful spin-off investing.
Unlike IPO's (roadshows and post IPO syndicates) analyst coverage on new spin-offs is severely limited leading to a lack of institutional sponsorship. Therefore, spin-offs don't get "talked up", hiding their inherent value. Spin-Offs are in effect new issues, but there is no underwriter or promoter telling the investment community what the company is worth.
Investment Advisors often recommend that their clients sell the spin-off shares indiscriminately because it often doesn't fit within the Advisor's financial planning framework. This works to the advantage of the astute investor.
Parent companies many times become acquisition targets after they complete a spin-off. This can be very lucrative.
Structural selling of spin-offs happens due to index fund selling (because the spin-off is not in the index), lack of yield, odd-lot selling and limited liquidity.
Many uninformed shareholders receive shares in a spin-off that they have not chosen to receive and think have no reason to keep, prompting them to sell them in a knee-jerk fashion.
Spin-offs are five times more likely to be acquired.
Spin-offs provide a means for the spun-off entity to secure better access to expansion capital.
Wall Street likes to apply a premium to "pure plays" which spin-offs represent.
Academic studies have confirmed that spin-offs on average have outperformed the general market (S&P 500) and that spin-offs many times improve the market performance of the parent company as well.
Citations
"Restructuring through spin-offs, equity carve-outs, and tracking stocks can create shareholder value. In the longer term, equity carve outs in which the parent company retains majority ownership easily outperform the Russell 2000 index, with an average annual total return to shareholders (TRS) in the two years after issue of 24% as compared with 11%. Spin-offs also substantially outperform the market, showing a two-year annualized TRS of 27%, compared with 14% for the Russell 2000 and 17% for the S&P 500." Tracking stocks returned 19%. Overall, the average improvement in the P/E multiple of the consolidated parent and subsidiary outperformed the market by 21%.
Study of the performance of 168 large ownership restructurings-- those in which the parent company had revenues upward of $200 million at the time of disaggregation--that have taken place in the United States during the time period 1988-1998. The study was published in The McKinsey Quarterly, 1999 Number 1, pp. 16-27
A 1998 working paper from Pennsylvania State University examined 83 equity carve-outs done between 1981 and 1990, and found that carved-out companies had significantly higher revenue and asset growth, higher earnings, and higher capital spending than the industry average during the first three years after the carve-outs. A similar study by J.P. Morgan & Co. which examined 101 carve-outs between 1986 and 1997, documented that, on average, the share price of the parent rose between 3-4% in the 90 days following the announcement of a carve-out. In the case of 12 carve-out companies in which the parent announced there would be a later spin-off, the share price of the carve-out performed 11% above the market 18 months after the initial public offering.
CFO Magazine, March 1999, pp. 97-98
A sample of 174 spin-offs, followed by Professors James Miles and Randall Woolridge of the Smeal School of Business at Penn State University between 1965 and 1994, returned an average of 18% in the first year, 51% in the first two years and 76% in the first three years outpacing the S&P 500 by 31%.
Bloomberg Personal Finance, September 1999, p. 27 and Spin-Off to Pay-Off, An Analytical Guide To Investing In Corporate Divestitures by Joseph W. Cornell, CFA, p. 32
"Over the two-year period prior to the spin-off, the stock price of the average parent company outperforms the stock market by 35% on average. After the spin-offs, stock returns of both the parent and the spin-off outperform the market, on average. Over the entire three-year period, assuming portfolio rebalancing, we find a compounded raw return of 106.6%, which corresponds to a compounded annual return of 27.4%. The largest returns come between one and two years after the distribution month. "
"Some New Evidence That Spin-Offs Create Value" by professors James Miles and Randall Woolridge of Penn State University, and Patrick Cusatis of Lehman Brothers. (See "Spin-Off to Pay-Off, An Analytical Guide To Investing In Corporate Divestitures" by Joseph W. Cornell, CFA, pp. 33, 35)
A J.P. Morgan study of 231 spin-offs and carve-outs between 1985 through 1998 found that during the first 18 months of trading, straight spin-offs beat the S&P 500 by 11.3% vs. 10.1% for carve-outs.
Business Week, December 13, 1999 p. 198
"Spin-Offs create opportunity through inherent neglect."
Andy Graves, Portfolio Manager for Brandywine and Brandywine Blue Funds
Spin-Offs with promising longer-term fundamentals should be purchased no later than six months after the spin-off. Price performance suggests that this is typically an optimal period to selectively buy this class of security. Buying at this time would have yielded the maximum price appreciation over the ensuing 12 to 18 months.
Spin-Off to Pay-Off, An Analytical Guide To Investing In Corporate Divestitures by Joseph W. Cornell, CFA, p. 66
These studies demonstrated that the announcement of a corporate spin-off or carve-out is associated with positive stock price movements in the parent's stock.
Schipper and Smith, 1986 (carve-outs), Hite and Owers, 1983, Miles and Rosenfeld, 1983 and Schipper and Smith, 1983 (spin-offs)
A J.P. Morgan study of 77 spin-offs from 1985 through 1995 shows that spin-offs outperform the stock market by more than 20% on average during the first 18 months after the transaction. The same study found that parent companies outperform the overall stock market by 5 to 6%, on average, between the spin-off announcement date and the actual spin-off. There is considerable academic research on spin-offs that suggests that they outperform the general market by a considerable margin. Hite and Owers, Shipper and Smith, and Miles and Rosenfeld document a mean abnormal spin-off announcement return of approximately 3%.
Hite and Owers, "Security Price Reactions Around Corporate Spin-Off Announcements," Journal of Financial Economics, 1983, vol. 12(4), pp. 409-436; Schipper and Smith, Effects of Restructuring on Shareholders Wealth: The Case of Voluntary Spin-Offs," Journal of Financial Economics, 1983, vol. 12(4), pp. 437-468; and Miles and Rosenfeld, "The Effect of Voluntary Spin-Off Announcements on Shareholder Wealth," Journal of Financial Economics, 1983, vol. 38, pp. 1597-1606 each documents a mean abnormal spin-off announcement return of approximately three percent.
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