Corporate Spin-Offs–Bloomberg Spin-Offs Index: Valued–Parts Greater Than Whole… Focus on Core, Hunt for Value-Growth…

Spin-offs: Merger-mania and bigger-is-better management mentality largely ruled the business world, but there are exceptions: Spin-offs. These provide an alternate path to prosperity, if the organization can weather the storms of such a radical change.

Among the keys for spin-off success are supportive management and flexible employees… Not all spin-offs work, but they do create more transparency-clarity about the parent company, and the spin-off entity, itself… and that benefits all stakeholders… Breaking up may be hard to do, but sometimes it’s necessary.

spin-off1 110627a301(1)In the corporate world, bigger is not always better… splitting-off parts (i.e, division, subsidiary..) of companies and establish them as separate independent companies is becoming a popular strategy for improving overall company value and growth… The basic rationale behind spin-offs is simply; the company parts are greater in value than the whole company…

However, there are real and strategic reasons for implementing a corporate spin-off strategy, for example; focus on core activities, deconsolidate, unlock shareholder value, grow faster, grow in new dimensions, greater value as separate entity, incompatible with overall branding strategy, regulatory reason, structure for merger, tax advantages…

Spin-offs are common corporate maneuvers and according to an analysis of ‘Bloomberg Spin-Off Index’ (the Index is made-up of stocks that were spun-off from top U.S. companies within the past three years)– spin-offs outperformed the S&P 500 by 233% from 2003 through 2012, and the Index has gained 39.7% this year, topping the S&P 500’s gain of 11.1%.

According to ‘Spin-Off Advisors’; there have been nine spin-offs completed, so far in 2013, putting it on pace to be the busiest year for such deals in a while… A strong year for spin-offs would reverse a rocky stretch for these type deals… as companies, instead, focused on cost cutting as a way to improve returns. Last year’s total of 37 spin-offs was down from 47 in 2011; though up from just 20 in each 2010 and 2009… Spun-off companies tend to be more focus and management has greater incentive to perform well, than when the company was a divisions of larger entities…

Typically, spin-offs are better capitalized and have more freedom to reinvest in the business. Although tax rules have permitted spin-offs since mid-1950s, spin-offs deals did not occur with much frequency or within major corporations until the 1980s, when the trend was ushered in by spin-offs of seven regional Bell companies by AT&T in 1982-1983.

According to David Sadtler; the number and value of corporate spin-offs has escalated since 1980s, for example; spin-offs accounted for less than 10% of U.S. divestitures in the 1980s, and then accounted for almost 50% by the late 1990s; this trend is continues to grow, even in current market environment.

According to Warren Batts; many spin-offs are run a lot better as independent companies than as wards of huge corporations… you attract far better managers to spin-offs than divisions of large companies… What makes spin-offs worth exploring is that those that succeed provide some of the most spectacular payoffs-paybacks around…

In the article Spin-offs, a Chance to Jettison Liabilities by Steven M. Davidoff writes:  A spin-off is a product of Wall Street math that says one plus one can equal three. Yet as shareholders may find out, it can also be all about subtraction, as a company ditches an unwanted business…

The business argument for a spin-off is typically that a separation of the assets allows both the parent company and the newly independent spin-off company to be better run, freeing management to take bolder steps with the new company. And since Wall Street is a place where magic works, the market will recognize this, giving each of the separated companies a higher valuation; and there is evidence of this effect.

Studies of spin-offs have found that they produce short-term gains, although in many cases these gains evaporate over the long-term… Spin-offs, not surprisingly, are big business these days on Wall Street. Last year, there were 85 spin-offs worldwide worth $109 billion, according to Dealogic, down just a bit from 93 spin-offs worth $128 billion in 2011.

However, spin-offs have a dark side, as they can serve as a convenient dumping ground, where liabilities can be freely attached to the company being spun-off: This is often management’s best opportunity to burnish its own company at another’s expense– it’s hard to resist…

A spin-off may be a good move for some companies and its management; saving them the trouble of having to turn around the business. However, the real question is– whether it’s just a way for a company to take out the trash and leave yet another wounded spin-off to struggle in the market. This may satisfy the Wall Street magicians, but how does it actually create value?

In the article Simple Anomaly That’s Been Crushing The Market For Decades by Eric Falkenstein writes: The straightforward strategy of buying companies that have recently been spun-off from their parent has generated very good results.  Here’s the performance of the ‘Bloomberg Spin-Off Index’ (BNSPIN Index) since 2003. As you can see, it’s pretty good, 15% annualized return vs. 6% for the S&P500 over that period. Volatility was higher but not extremely so (20% vs. 15%), while the beta was pretty close to 1.0.

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Is this a crazy recent phenomenon? ‘No’. In 2003 ‘McConnell and Ovtchinikov’ looked at 311 spin-offs undertaken by 267 parent companies between January 1965 and December 2000. And, on average, subsidiaries outperformed their benchmark companies by over 20% over the first three years following the spin-offs, with most of the excess returns within the first 12 months of trading.

They found the parent company outperformed as well, but not by a robust amount… I don’t think there’s a rational explanation for this. I remember at Moody when they just spun-off from Dunn & Bradstreet (D&B), it was really liberating. For years D&B had used the considerable Moody’s cash flow to fund their dumb ideas to extend D&B, which really ran the executive board, while Moody’s made all the money.

It was classic waste of shareholder money, and when the spin-off finally happened in 2000, Moody (MCO) stopped burning its cash and investors reaped the windfall (32% return, annualized, from 2000-present). It’s amazing how much money is wasted via such politics, but it’s a classic case of bad incentives and difficult monitoring…

It makes one wonder about the value potential in Citi (C). If someone could force it to spin-off itself into pieces, most everyone with defensible interests will be pleased. Letting $120 billion company under perform is really painful to behold. The only people such behemoths serve now are a select group of executives, politicians, but not shareholders, consumers, or 99.99% of Citi employees…

In the article Art of the Spin-off  by ‘The Economist’ writes: In the entertainment world spin-offs are the offspring of hit shows. You take popular characters and give them their own programs or mature franchises and give them a new twist… In business, spin-offs are the offspring of established companies– take a division and turn it into a free-standing firm…

According to Forbes; U.S. companies completed more than 80 spin-offs and valued at least $500m each between 2002 and 2012. The parent companies (or ‘spinners’) have delivered a return of 35%, compared with 22% for the S&P 500. The ‘spun’ have delivered a return of 70%. Returns for firms in the ‘Bloomberg Spin-Off Index’ were 47% over the past 12 months compared with 16% for the S&P 500…

However, managing spin-offs is tricky, for example; companies can appear to be tossing out ‘trash’ and keeping ‘cash’… and, they can damage long-standing relations with employees, investors, and suppliers… Both spinners and spun are odd hybrids; parent company with long a history and a new spin-off company– that share close ties with each other…

But, veterans of the various splits are justly proud: Managers boast that they were engaged in strategic corporate regeneration, not just rebranding… In many ways creating new companies out of existing ones is harder than creating new companies out of nothing…

Spin-offs are complicated transactions that require a great deal of advance planning. In many cases, an announcement that a parent company is considering a spin-off actually starts a ‘dual-track’ process, i.e., while a company considers and plans for the spin-off, it also remains open from third parties to acquire the business…

Spin-offs come in two forms: voluntary and involuntary. Where voluntary spin-offs, typically, are subsidiaries that are not core business, and not necessarily essential to the parent company, whereas, involuntary spin-offs generally result from a federal or state regulatory agencies’ action…

According to David Sadtler; release of latent company value is the ultimate motivation for spin-offs, and spin-offs, generally, result in increased value because they remove factors that impede the growth of value… In a study, ‘Robert Comment and Gregg Jarrell’ examined many companies involved in spin-offs over a three-year period and discovered that companies that spun-off subsidiaries performed about 7% better than companies that diversified. However, other studies present a different view of spin-off effects.

A ‘Clarus Research Performance Database’ study of spin-offs by the world’s 500 largest companies between 1996-1998 indicated; companies involved in spin-offs tended to under perform the market by 17% after announcement; suggesting that spinning a subsidiary off will not necessarily lead to an increase in value; in and of itself... however, companies that did increase value– they implemented restructuring and refocusing initiatives; in addition to spin-offs…

Spin-offs are transformative, which means both companies (i.e., spinner and spun) must carefully assess their post-deal strategy, as well as, their financial and governance positioning… Numerous academic studies suggest that many spin-offs show significant value appreciation, both on absolute and relative basis.

However, once removed from the parent company, the newly independent spin-offs frequently undergo significant internal-external changes, requiring much planning-adjustment during the crucial periods of uncertainty… Breaking up may be hard to do, but sometimes it’s necessary.