Alcoa, the aluminum company that traces its history back to the 19th century, says it will split into two pieces in 2016, spinning off its "value-added" manufacturing business to create more value for shareholders.
Where have we heard this before? We hear it every week, actually. In 2014 in the United States, according to Spin-Off Research, there were 56 spinoffs, in which a publicly traded company splits up and spins off one or more subsidiaries via IPO or by distributing shares to stockholders. We're on track for 52 spinoffs in 2015, the firm says.
There's no doubt that spinoffs create wealth for investment bankers, thanks to all those deal fees. But for some time, they've also made money for shareholders, too. It's not so much the first pop of euphoria when a transaction is announced, but, the investing thesis goes, a longer-term gain, starting about six months after the spin and ending about two years after.
That time frame is what the Guggenheim Spin-Off exchange-traded fund (CSD-NYSE) used to steadily outperform the S&P 500 and, when I first wrote about the phenomenon last December, earn five stars from the research firm Morningstar. But something has happened since: The Guggenheim ETF is down nearly 15 per cent so far this year, worse than the S&P 500's 5-per-cent decline. Add in a trailing performance for 2014, and the ETF now has three stars, not five, from Morningstar.
Into every life a little rain must fall, and there are a number of spinoff clunkers in the fund. But the performance raises another question: Are the recent returns a function of randomness, or should we re-evaluate the spinoff investing thesis?
Let's review some of the ideas behind it. While companies' stocks pop when they announce a strategic review, or the decision to split up, that gain often erodes as investors realize the transaction will take months to complete. Institutional holders of the shares might not find the pieces of the breakup suitable, so there's initial selling pressure in the early days and weeks before and after the spin. Six months after the transaction, then, is often when the dust settles and the management of the spinoff has had time to focus on the new, pared-down enterprise. And the fruits of that labour arrive in the quarters to follow.
Joe Cornell, publisher of Spin-Off Research, however, now wonders whether waiting six months to invest is too long. "The market is pretty efficient. You don't see huge sell-offs any longer because it is a 'spinoff.'"
Mr. Cornell's research examines each case on its own merits, and he begins analysis on the parent before the spinoff is complete. His firm's "focus list" includes Community Health Systems Inc., a hospital company that intends to spin out some of its properties and its management company in early 2016 (Spin-Off Research sees 37 per cent upside from Thursday's share price) and Babcock & Wilcox Enterprises Inc. (30 per cent upside), a June spinoff from a similarly named parent.
Notably, none of the nine companies on Spin-Off Research's focus list has made it into the Guggenheim Spin-Off fund, which tracks the Beacon Spin-Off index. The index adds companies once they've traded for six months, and removes them after 30 months, postspin, thereby capturing two years of postspin performance.
The fund added nine stocks in June; six of them have lost a third of their value in the past four months, including Rayonier Advanced Materials Inc. (minus 54 per cent) and Timkensteel Corp. (minus 52 per cent). The damage isn't limited to the recent additions: Altisource Asset Management Corp., a real estate portfolio management company that has been in the fund for all of 2015, has lost nearly 90 per cent of its value this year.
Perhaps, of course, we are getting too hung up on short-term results. The fund is jockeying for the top spot among all midcap-blend style U.S. equity ETFs in returns since the market bottom of March 10, 2009, with a gain on nearly 25 per cent, annualized.
"While, admittedly, we're on a year-plus period of underperformance, we look at it over a much longer time period and still feel shareholders have been rewarded for sticking with the strategy," says Bill Belden, manager of the Guggenheim Spin-Off fund. "Our eyes are very open to these issues, but I don't think we've reached the time where we'd actively pursue a re-visitation of methodology."
There might be something else at work here. In a period where more and more companies choose spinoffs, it's possible the earliest practitioners are splitting up for substantive reasons. As the trend continues, though, it risks becoming a fad – and perhaps companies who are late to the party are producing parts that are less than the sum of the whole.