spinoffs …do they create value?

My daughter asked me this the other day.

My answer is:  most times, yes.

I’m going to elaborate in today’s post, and in the next two days’ as well.

Let’s get started–

what it is

spinoff  is when a company with multiple lines of business, say ABC, separates one line, say, C, and divests it.

lots of variations

There are two main separation techniques:

a)  sale to another company, or

b)  distribution to existing shareholders, who then own shares of now-AB + shares of C.

In the normal way Wall Street works, there are lots of varieties of both sale and distribution–a portion of the shares of C, all the shares of C, or a portion now followed by the rest later.  In perhaps the most complicated case, a partial distribution cum IPO can be followed by a sale of the remainder into the open market.  This means the proceeds of the follow-on sale go to the corporate coffers of AB.

adding value

This can happen in a number of ways.  The one I’ll write about today is for publicly traded companies only.  It’s the portfolio effect.

It’s the idea that any publicly traded multi-line company is like a portfolio of mono-line firms in the eyes of a professional equity portfolio manager who might be thinking of buying shares for his clients.

A PM may be looking to establish a position in industry A.  Maybe he thinks that low oil prices will be with us for longer than most people think and that he should add to his holdings in petrochemical companies because of this.  He’s interested in pure petrochemicals plays.  At the same time, he does not want exposure to oil and gas exploration and production.  So a hydrocarbon conglomerate like any of the large integrated oil companies–which have both exploration and chemicals–raises conflicting emotions.

He is willing to pay a full price for the chemicals   …but you have to compensate him for being forced to take the exploration business he doesn’t want..

At the same time, there may be PMs with the opposite view.  They’re willing to pay up for the exploration but don’t want the chemicals at all.

Both PMs are stuck with stuff they actively don’t want if they buy the conglomerate.  So, in theory–and most often in practice–the stock market value of the business AB is less than if both A and B traded separately.

One might argue that there’s some hedging value to having both a part that benefits from higher hydrocarbon prices and one that benefits from lower.  Maybe, although it’s not my cup of tea.

Even so, there are plenty of companies with completely unconnected lines.  Take Swire Pacific in Hong Kong.  The modern iteration of one of the old British opium companies, it consists basically of property and an airline, Cathay Pacific.  When it announced years ago it was spinning off a portion of the airline– creating a pure play transportation stock + a purer property play, the stock went up by 40% in anticipation of the portfolio effect.  Airline buyers would no longer be stuck with office buildings; property buyers would no longer be stuck with an airline.

 

More tomorrow.

 

 

One response

  1. Hello,

    Spinoffs are decided by management, and I’m more interested in them in the stock holder getting benefits point of view.

    I think the point here is to ask ourselves: “Ok, there is a spinoff announcement, but will it be valuable for as an investor? Will it add value to the company and to my global return? Or is it a bad move? What does really want the company assessing this strategy?”

    Actually, sometimes spinoffs don’t really create value, as the opposite can be true. But I’m really concerned about the objective and motivation behind the management thinking, which isn’t always obvious. And to me, that’s the really important thing there is to consider.

    I really enjoyed getting a clearer explanation about spinoffs, so thank you for this sharing.

    Please come visit my blog: https://ivmoats.wordpress.com/

    To successful investing

    Samir

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