spinoffs: sometimes toxic, sometimes hidden gold

The March 12th edition of the New York Times’ excellent Dealbook section has an article written by Buckeye professor Steven Davidoff, titled “In Spinoffs, a Chance to Jettison Liabilities.”  It’s well worth reading.

spinoffs

In it, Mr. Davidoff documents how in a spinoff ( which is when publicly listed companies separate out a chunk of themselves into a separate legal entity, whose shares they then distribute to existing shareholders) the parent companies sometimes have ulterior motives.  (…shocking!)

being left behind on an ice floe

Many times, such “spinoffs” are businesses the parent wants to sell but can’t find buyers for.  They often are loaded up with a disproportionately large amount of the company’s debt.  Sometimes the spinoff is even forced to take out new loans and turn the proceeds over to the parent before it’s launched.  Davidoff gives lots of examples.

One of my favorites is the case of Monsanto, which spun off its industrial chemicals and fiber operations as Solutia, to get rid of liabilities relating to its production of PCBs.  It later spun off its agricultural businesses as the “new” Monsanto, retaining its pharmaceutical businesses in the parent, which was renamed Pharmacia.  Spinoff Monsanto was forced to agree to compensate Pharmacia for any losses it might suffer from Solutia-related litigation.  Sort of like a belt and suspenders.

three points

–None of this spinoff-unfriendly activity takes place completely in secret.  Somewhere in the SEC filings all of the potential bad stuff is disclosed.  Don’t expect it to be to be highlighted in LARGE print and a bold typeface.

There is a quick and dirty way to help focus your attention, though.  See where the current CEO is going end up.  There’ll never be potentially toxic liabilities there.  Look at the other parts of the deal.

–Not all spinoffs are disasters waiting to happen.  There’s a legitimate case to be made against conglomerates.  If a company has, say, two unrelated businesses, one which generates tons of cash flow but has few growth prospects, and a second that has huge growth opportunities, it may make sense to separate the two.  Income investors will bid up the price of the first, growth investors the second.  The sum of the two parts can be worth much more than the original conglomerate.

Sometimes, too, a small growth business can be lost in a much larger entity and starved of capital.  Spinoff will allow it to flower.

Two things to look for:  in my experience, it’s a good sign if the spinoff is relatively small and doesn’t “fit” with the rest of  the firm (think:  Sara Lee and Coach).  Also, it’s a plus if the parent retains an interest in the spinoff.

–There’s a perverse, human nature aspect to the spinoff game.

A captain, dying to get his own ship–even if it is rapidly taking on water–may be unduly optimistic in talking about his new command.

On the other hand, if you’re a shrewd businessman, once you learn your division is going to be spun off–usually at least a year, maybe two, in advance–you know there’s no sense in shining up the business any more until it’s its own public entity.  Improving your business pre-spinoff only makes your post-spinoff job harder!!  Best just to go on vacation for a while.  The result:  a “good” spinoff can be shockingly good in the first few years.

One response

  1. Interesting article, I knew there was business taking place like this but didn’t think it was so popular. Especially, if it’s right there in the SEC Information. Nice Topic

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