October 13, 2018
You Should Be Looking At Spinoffs as markets continue to soar
With Soaring markets and the rise of shareholder activism have compelled companies to plan spinoffs at a rate unseen since at least 2008. There’s no end in sight for the frenzy as these new stocks keep finding ways to beat the market.
More than 100 companies this year have announced plans for spinoffs on U.S. exchanges, a 54 percent increase from the same time last year, according to data compiled by Bloomberg. This momentum could continue regardless of how the broader market performs, according to Jason Reynolds, a deals analyst at Hampton Trading, “The pace of change is set and if the market goes higher, we will see management needing to realize value when valuations are full. Even if markets reverse, companies will still need to look like they are creating value.”
Spinoff Activity Peaks in 2018
U.S. companies planning separations at highest pace since the credit crisis
Source: Bloomberg Data
Reynolds credits the surge to increased activism and strong performance of spinoffs over the past year. The Bloomberg US Spinoff Index (BNSPIN) tracks recent spinoffs, has gained 22 percent over the past year, outpacing a 13 percent gain in the S&P 500 Index.
Shares of Danaher jumped by as much as 7.4 percent after the company said it planned to separate its dental business. More spinoff news could be in store after earnings reports; as with General Electric and Honeywell which are both planning to spin off business units.
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 are 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 is 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 as well.
The 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 rationale behind a spin-off or a carve-out (partial IPO) is that the “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, often outstanding overall performance is observed.
The Bloomberg U.S. Spin-Off Index (BNSPIN) is a market capitalization weighted index that contains stocks over 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 Bloomberg Spin-Off Index has crushed the S&P 500 since inception (the index goes back to 2003). Since 2003, the Bloomberg Spin-Off Index has generated a total return of 1,030%, versus 194% for the S&P 500 Index. Over the past 12 months in Spin Index has returned 31.9% versus 12.8% for the stock market.
For the 10-year period, the Bloomberg Spin-Off Index has appreciated 342% (versus 154% for the S&P 500 Index). Over the past three years the spin index is up 60% versus 35% for the S&P 500. For the 10 year period (as of March 28), the spin index has returned 342% versus 154% for the market (S&P 500).
“It appears that 2018 will continue to be a banner year for spin-offs as well as 2019,” noted Mr. Jason Reynolds.
Contact us for our latest view on planned spin-off for 2018 as well as next year’s planned activity.
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