Value Investing

What Is A Spinoff?

The ability to see into the future – a decent skill if you have it…

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Stock Spinoff
kulinetto / Pixabay

What is a Spinoff?

I used to say to people, “I don’t know what is going to happen. I don’t have a crystal ball.” It was probably the right thing to say 10 years ago, but today, our client partners and your investors (if you have any) are essentially paying you to have that skill and expect it! Quite a feat. We will return to this a little later.

In the meantime, this newsletter goes out to tens of thousands of people, and to be honest, I don’t really know who most of you are. However, my last newsletter touched on why you need Spinoffs in your portfolio. On the back of that, I received many emails asking if I could concisely explain what a Spinoff is, so I’d thought I’d lead this week with exactly that.

A Spinoff is the creation of an independent company through the distribution of new shares of an existing business or division of a parent company.

“Nice one, Jim,” I hear you say, “but what does that really mean to me as an investor?” Well, there are many angles to consider. Here are three of the most important.

1. Definition – This is the basis of getting these situations right. I will tell you what a Spinoff is not. It’s not a sale, it’s not an IPO and it’s not a divesture within a business. A true Spinoff occurs when you, as the shareholder of the company, receive shares of another company by holding that parent company. A true Spinoff occurs by distribution. Just a side note: the press has forever got the definition wrong. Just look a little closer when they write about it. In my opinion, it is essential that it happens this way as a means for starting an investigation into a potential investment. Receiving shares in a stock whether you want them or not throws up all sorts of issues to think about. I will save the rest of the reasons why Spinoffs can be good sources of investments for another time, but this is one of the most important that people rarely mention. Also remember, it can go by the name of breakup and divestiture, but a “true” Spinoff is what has been described. It must be by distribution.

2. Dates – This is key. When a Spinoff is announced, it can take up to 18 months for the event to materialise. Interesting to note, our 14-year Spinoff Study with Deloitte (available for purchase) shows that companies who prepare more than six months ahead of the Spinoff produce 2x better returns. Post-announcement it will often go very quiet. Unless you closely track that Spinoff, or alternatively have someone to track it for you, you will more than likely miss it. Along the journey, you should be watching for new Form 10 filings, updates in earnings about performance and continually updating your model with the financials produced. If you have managed to do all that, then make sure you hold the parent shares before that important “record date.” That will ensure you get the Spinoff entity. Miss that and you maybe be able to pick up the shares in the when-issued market or when it goes regular trading. I’ve always been a fan of pre-spin. You never know what happens.

3. Investable Opportunity – This is the area where you should be doing your homework. Here is my best tip: Find out first why the company is doing the Spinoff. This is the part most analysts miss. They decide to jump on the numbers. The real key to starting any analysis is this precise point. You will get the signposts on where to go to lead your investigation. It’s what we do here. Sometimes the reason is quite generic. Common generic reasons include, “We believe the companies will function better on their own,” and “Independence is needed to realise each individual company value.” Again, read between the lines and you will discover more. You will need to analyse pre-and post-spin companies to see if there is any value. Should you buy the stock before it spins or after? Furthermore, consider the shareholders and management. Who are the major shareholders and why do they hold the stock? Who are the management specifically and how are they incentivised? Have they been buying any shares recently? Depending on their amount and how much they already own, buying could be a good sign. Finally, consider the index that the names are about to go in or come out of. Many larger index funds cannot hold small names and they will need to be sold, putting pressure on many Spinoffs in their early days. Consequently, when companies are big enough to go into indices, the opposite happens. Quantify all of this.

Lastly, back to the crystal ball thing. Look, the more I do this, the more I try to look at clues in companies which will give me the insight into what they will become. They can and usually are hidden within the numbers and transcripts. Spinoffs are great hunting grounds and they are unlike IPOs because no investment bank needs to push the stock. This makes it more interesting for me, anyway. Ultimately, you will gather a picture of what can develop. Remember, most if not all the information you need is out there. Just do the digging to find it.

I trust this has given you good insight about Spinoffs. There is much more to it and, again, it’s what we do. There are about 35-40 larger Spinoffs per year. If you feel like you are missing out on this niche part of the market that is difficult to analyse and follow, fill out the webform and let’s talk. We have products for the small and large investor. I would love to hear from you. Alternatively, send me a direct email below.

Jim Osman CEO

Article by Edge C Group