Don't mistake a spin-off for a throwaway: Spin-off companiesoften
outperform their parents.
By Peter Lynch
Imagine this scenario: you're a shareholder in Quaker Oats,because
you think it is a good investment and you like the oatmeal.One day the
mail brings free shares of Fisher-Price, a QuakerOats subsidiary that's
now being turned loose as a separate company.You call your broker to
ask how Fisher-Price is doing. You findout it has been losing money for
several quarters, so you thinkto yourself, Why keep this dog? You sell
the shares as soon asthey start trading, and you are happy to receive $11
for each.After all, you got them for free.
A couple of years later, you're browsing through the stock pages,and
you come across Fisher-Price. Those $11 shares have become$38 shares,
and you wish you hadn't noticed it, because now yourealize you missed
a chance to more than triple your money onthe giveaway, while Quaker
Oats (which you still own) is up amodest 10 percent.
When a subsidiary or a division is booted out of the nest ofa parent
company, it's called a spin-off. Lately, we've seena lot of these. After
decades of trying to diversifyDor as Icall it, diworsifyDmany companies
are returning to their coreoperations. The buzzword for this is
"rightsizing." If a divisiondoesn't fit in with a company's main line of
work, the companysells it or spins it off.
A spin-off happens in two stages. First, the parent companyissues stock
in the offspring and sells a small percentage ofit in a public offering. The
rest is distributed as a gift (oftentax free) to shareholders of the parent.
What makes these dealsso intriguing is that spin-offs tend to do better
than stocksin general, particularly in the first 24 to 36 months after
theyget their independence. On the next page is a table showing someof
the most impressive performers of the 1980s and '90s.
Two Wall Street analysts are making a career out of spin-offs:Barbara
Goodstein at Rothschild and Patrick Cusatis at LehmanBrothers. Cusatis
says he got the idea from reading my firstbook, One Up on Wall Street,
which contains a short section onthe subject. I'm gratified that he paid
such close attention.He traced 161 spin-offs going back as far as 1965
and made anintriguing discovery: 14 percent of these spin-offs became
takeovertargets and ended up as divisions in other companies, usuallyin
the same industry.
Fisher-Price is a typical example. This liberated toy companywas on its
own for less than three years before Mattel snappedit up. It made no
sense at Quaker Oats, but it was a fine complementto Mattel.
I look at a lot of numbers every week, but the 14 percent takeoverrate
made an impression. With companies in general, the oddsof a takeover
are only 3 to 4 percent, so the shareholders ina spin-off are three to four
times more likely to benefit fromone of these potentially lucrative
episodes. In a takeover, thestock price is a cinch to go up.
It's no accident that spin-offs have done well. The managersno longer
take orders from above and cut costs in obvious waysthat the old regime
overlooked (this is called grabbing the low-hangingfruit). They become
more entrepreneurial. The parent companymay have a financial stake in
the success of the spin-off. Certainly,it has an emotional stake. The last
thing a parent company wantsis for one of its own projects to flop. So it
tries to do everythingpossible to help the fledgling enterprise, from
cleaning up thebalance sheet to installing good management. A company
that hasto jettison divisions in a fire sale to raise cash may not careabout
the consequences, but a powerhouse like Coca-Cola certainlydoes.
Coca-Cola spun off Columbia Pictures in late 1987 (keeping a49 percent
interest), and when Columbia proved to be a disappointment,Coke did
what it could to turn things around. Then it found abuyer at a fancy
price. In 1989, Sony acquired Columbia for $27a share, more than three
times higher than where shares firsttraded.
The most complicated separation was the Baby Bells. If you owneda
share in AT&T in 1983, you got fractions of shares in sevenspin-offs
at once. A lot of people thought this was a nuisance,but those who held
on to their fractions were well-rewarded.The Baby Bells did the easy
cost-cutting and had a great sixyears while AT&T languished.
In many of these spin-off situations, you've got two forcespulling at the
stock price from opposite directions. On one sideare the mutual funds
that own shares in the parent but can'tget involved with the offspring.
For instance, the S&P Indexfunds must sell whatever shares they get
from a spin-off if thenew company isn't in the S&P 500. While the funds
are dumpingtheir holdings, so are individuals who don't want to be
botheredwith upstarts they know nothing about.
On the other side are buyers who understand the virtues of spin-offsand
scoop up the shares at what they perceive to be bargain prices.This
often results in a standoff that may last for several months,until the new
company has a chance to prove itself and impressthe Wall Street
kibitzers. Take Gardner Denver Machinery, a manufacturerof air
compressors and blowers, which emerged from Cooper Industries in
April 1994. The stock was stuck in a trading rut for nearlya year until it
surprised the Street with better than expectedearnings. Only recently did
Gardner Denver jump the rut.
Tandy is one of the champions of spinning things off, sendingso many
divisions out into the world that its genealogy beginsto sound like the
families of Levites from the Old Testament.In 1975, Tandy begat
Tandycrafts and Tandy Brands, and the shareholdersgot free shares
in both. Then, in 1976, Tandycrafts begat Stafford-Lowdon.Three years
later, it begat Colortile, and in 1986 it begat InterTAN,one of the few
losers in this crowd. Tandy Brands, meanwhile,changed its name to
Bombay Company, which in 1991 begat TandyBrands Accessories. If
you had invested $5,000 in Tandy in 1975and held on to the whole lot,
you would have $86,000 by now.
The latest trend from the boardroom is for companies with twoor three
giant divisions to divide themselves into equal parts.Usually, they take
this action because they think investors havefailed to appreciate the true
value of the sum of the parts.In other words, the stock price is too low.
Thus, Sears spunoff Allstate, 80 percent of which will go to Sears
shareholdersas a tax-free gift sometime this summer. |
