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Building Wealth with Spinoffs: How Adding These Gems Can Transform Your Portfolio

Barchart - Thu Aug 31, 4:57AM CDT

Imagine discovering a treasure map that leads to the chest containing the loot. Consider that the investment world has its own version of these concealed treasures: Spinoffs. These financial treasures have the potential to reshape your entire investment voyage, not just enhance your portfolio. The catch? You must look for them and do some work. A tough ask, I know.

What is A Spinoff?

In a Spinoff, a parent company separates one of its business entities or divisions into a standalone, independent company. By distributing shares of the spun-off company to the current proprietors of the parent, two separate publicly listed entities are created. The new enterprise that emerges because of a Spinoff is often referred to as a "Spinoff company." Spinoffs can increase shareholder value by allowing distinct companies to focus on their core competencies and releasing hidden value in specific business divisions. In addition, it offers investors the option to invest in various companies based on their investment preferences and risk tolerance. Or, alternatively, eradicate them.

The media frequently gets it wrong when speaking about Spinoffs. This is a very important point to remember. A ‘true’ Spinoff only happens when a share of a division is distributed amongst existing shareholders that own the parent company. Contrary to the media, IPOs, Divestitures, carve-outs, split-offs, and split-ups are not Spinoffs and consequently, these transactions lose many of the value creating dynamics of the Spinoff corporate action. Cross-reference information from various trustworthy sources, particularly official business communication. To fully comprehend the Spinoff and its ramifications, investors should also look for information from reliable financial analysts, subject-matter experts, and formal regulatory filings, such as those with the Securities and Exchange Commission (SEC).

Do Spinoffs Outperform? 

The “Spinoff” is an essentially inefficient method for distributing stock to the incorrect individuals. You receive shares whether you desire them or not. Typically, investors acquire these shares by default and sell them on the open market almost immediately, making them inexpensive companies that no one is interested in. They are occasionally referred to as "orphan securities." At this point, X marks the location, and digging should commence.

Why the dynamics of Spinoffs make it an essential area for an investor to analyze:

  • Studies have shown that Spinoffs have historically beaten the market by over 10 percent as the pure, newly focused business takes off.
  • Compensation for executives can be more closely correlated with business performance. The company will become smaller, which will increase the executives' motivation and sense of ownership.
  • Separating companies allows each entity to be properly valued and can sometimes unlock a “conglomerate discount."
  • Due to the likelihood that the company would be small and lack a roadshow, it is under-followed. As a result, there are more chances for investors to discover returns greater than the index.
  • The Edge Consulting Groups 20 year study shows that Spinoffs are likely to be taken over. Roughly 35 percent are acquired around the two-year mark post-Spinoff.

Typically, there are hundreds of Spinoff situations a year. Around 40 have over $1 billion in market cap. This is a sweet spot where liquidity and “real” companies come together in my opinion.

5 Reasons Why You Should Be Looking For These Situations 

Including Spinoffs in your investment portfolio can provide a variety of benefits, including diversification, undervalued opportunities, and the potential for higher returns and enhanced performance.

  1. 1. Enhanced Diversification: Incorporating Spinoffs introduces a new layer of diversification. Since Spinoff companies often operate in different sectors than their parent companies, they can provide exposure to industries that might not have been represented in your portfolio. This helps spread risk and reduces the impact of negative events within a specific sector.
  2. 2. Undervalued Opportunities: Spinoffs are sometimes overlooked by the market, leading to potential undervaluation. This presents an opportunity for investors to purchase shares of promising companies at a lower price compared to their intrinsic value. As the market gradually recognizes their worth, these undervalued gems can yield substantial returns.
  3. 3. Focused Management: Spinoff companies can streamline operations and focus on their core competencies, which often leads to improved efficiency and performance. The management teams of these newly independent entities tend to be more agile and dedicated to the success of their specific business, potentially translating into better growth prospects.
  4. 4. Catalyst for Change: The newfound independence of a Spinoff can lead to strategic changes, such as cost-cutting initiatives, innovation, and targeted expansion plans. These changes can drive improved financial performance and boost shareholder value over time.
  5. 5. Potential for Outperformance: Historical data indicates that Spinoffs often outperform the broader market indices. This outperformance can be attributed to a combination of factors, including improved focus, better capital allocation decisions, and the market's eventual recognition of the Spinoff's value proposition.

Why isn’t Everybody Looking At Them?

I asked the legendary investor Joel Greenblatt this question once and he didn’t hesitate to give me the answer. ‘No one wants to do the work.’ Spinoffs analysis takes a lot of effort and, surprise, surprise, not many want to do it. However, as an investment veteran of over 30 years, I can categorically say that some of my most profitable ideas come from doing a hell of a lot of work and finding the angle and edge in the situation in this area. Furthermore, they are not promoted by brokers. Unlike an IPO there is no stock to sell you. You gain the Spinoff from holding the parent company whether you like it or not. This opens a whole range of dynamics that are interesting for investing. 

Recent Spinoffs That You May Know

AbbVie (ABBV)  (formerly known as Abbott Laboratories' biopharmaceutical business) was spun off from Abbott Laboratories in 2013. AbbVie has outperformed the S&P 500 by more than 200% since the spinoff.

Visa (V) was spun off from Bank of America (BAC) in 2008. Visa has outperformed the S&P 500 by more than 400% since Spinoff.

Mastercard (MA) was spun off from American Express (AXP) in 2006. Mastercard has outperformed the S&P 500 by more than 300% since Spinoff.

Agilent Technologies (A)  was spun off from Hewlett-Packard (HPQ)  in 1999. Agilent Technologies has outperformed the S&P 500 by more than 200% since the spinoff.

Johnson & Johnson's (JNJ)  Life Sciences division was spun off as a separate company called Janssen Pharmaceutical Companies in 2017. Janssen Pharmaceutical Companies has outperformed the S&P 500 by more than 50% since the spinoff.

These are just a few examples of successful stock Spinoffs. There are many other examples, and the success of a spinoff can vary depending on several factors, such as the underlying business, the management team, and the market condition.

In Summary 

If you are after hidden value where no one else is looking, look no further than this area of the market. There are services out there that can help, but ultimately a little hard work in a proven area will get you to some positive wealth creation a lot faster than competing with the masses.

On the date of publication, Jim Osman did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

Provided Content: Content provided by Barchart. The Globe and Mail was not involved, and material was not reviewed prior to publication.