Attractive Spinoff Criteria

What makes a spinoff attractive?  After picking this as a place to put my money, I need to understand what makes this type of investment valuable.  This post has the simple basic rules that make spinoffs attractive as an investment vehicle.

Institutions are motivated to dump the shares

Institutions (mostly mutual funds) are motivated to dump the shares of a spin off for a number of reasons: the size of the company is smaller than the minimum value the mutual fund can purchase or in an industry that the institution does not participate in.

Insiders are motivated to keep the shares

Management, and other wall street insiders are making sure that they get a cut of the new company’s shares.  These deals are typically disclosed in the SEC Form 10/12B.  Look for sweetheart deals that major investors are making for their interests.

The company becomes relatively cheap to purchase

The spin off provides an inexpensive company to purchase as a result of the spin off.  As institutions bail on the new company, the stock price can suffer providing a great opportunity for investment.

The company is a a great business that is only realized after the spin off

Sometimes the spin off company’s attractive investment was being dragged down by the parent.  This is particularly noticeable with spin offs created in entirely new industries.

The company provides a new leveraged risk reward situation

The new leverage is appropriate for the spin off’s industry but was inappropriate for the parent company’s industry making a new valuation model more useful and effective.  As a result, the new companies will be better valued like their peers.  This can happen when the two industries are starkly different.

Exploring Spin Offs

Exploring Spin offs

Spin off companies appear to be a place where one can consistently beat the S&P 500.  This post will explore this possible investment closer than previous posts.  If you would like to see my perspective on a spin off that occurred recently you can check out the posts I wrote on the Conduent spin off that occurred earlier this year.  Full disclosure, as of this writing I currently have 100 shares of Conduent and five long term options in Conduent and Xerox set to expire in 2019.

Corporate spin off opportunity from Xerox: Conduent

“Carefully study spin offs” – Charlie Munger

Risks

The risks associated with spin offs are numerous, so before a reader immediately goes out and buys every spin off they can find, some words of caution:

  1. A Deloitte study found that 4 out of 10 spin off companies do not generate a positive return in their first 12 months of trading.
  2. The same study found that the bottom quartile returned -39% over the first year.

You can find the Deloitte study by following this link.

Rewards

The return associated with spin offs is apparent in the Bloomberg Spinoff Index which from 2003 to 2016 returned approximately 15.58% while the S&P500 returned 8.88%!

Reasons Spin offs remain a good place to look for deals

  1. In a world of increasing index investing, many spin offs will be beaten down by institutions selling the shares of the new company outright because it will not be in the index.
  2. Institutions may also find that the recent spin off does not meet their investment expectations (like size or leverage amount) and they will again immediately dump the shares without considering the value of the investment.
  3. Sometimes these smaller companies demonstrate a new, previously undiscovered business opportunity.
  4. Investors often are wary (or haven’t heard) of these companies because many of them are not followed by analysts until after a few months of independence.

Conclusion

With a consistent way to outperform the S&P500, this seems to be a place I want to be in the stock market.  Next week HPE will be spinning off a portion of its business, as a current investor in HPE I will be looking at this spin off with great interest.