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Investing in and around spinoffs has been an extremely lucrative endeavor over the past decade, according to the Nov. 30 issue of Value Investor Insight. Indeed, since the end of 2002, Bloomberg has maintained a U.S. Spin-Off Index, which tracks the share prices of newly spun-off companies with market capitalizations of more than $1 billion for three years after they begin trading. Over the near 13-year period tracked, Bloomberg’s U.S. Spin-Off Index has risen 557%, compared to a return of 137% for the S&P 500. Moreover, spinoff activity is close to an all-time high as companies, spurred on by activists, try to unlock value for shareholders by splitting up their businesses. This year’s total number of spinoffs is expected to be 49, the fourth-highest level on record. However, more often than not, due to a number of factors, spinoffs are mispriced by the market, which can lead to some very attractive opportunities for value investors. In this month’s issue of Value Investor Insight , four spinoff experts – Murray Stahl of Horizon Kinetics, Joe Cornell of Spin-Off Advisors, The London Company’s Jeff Markunas and Jim Roumell of Roumell Asset Management – discuss the key factors that lead to spinoff mispricing and where they’re looking for opportunity today. (click to enlarge) Spinoffs: Four key factors There are four key structural factors that can lead to spinoffs being mispriced : Limited information – The documentation filed with the SEC when companies split can be quite complex, and the pro-forma financials can be difficult to analyze. Moreover, analyst coverage tends to be limited, and investors, rather than do the legwork themselves, would rather look elsewhere. Forced selling – A spinoff may see a parent company force a SpinCo onto a shareholder that doesn’t want, or legally can’t hold the shares, which will lead to selling. An S&P 500 Index fund can’t own a spinoff company outside the index, for example. Sandbagging – SpinCo managements usually receive significant financial incentives to underperform and over-deliver. Top managers’ incentive stock plans are typically based on average share prices of the spinoff company for the first 20 or so days of trading after the spinoff, which can lead to sandbagging of the highest order before those prices are locked in. ” Capitalism works ” – According to Value Investors Insight , when a SpinCo leaves its parent, “pent-up entrepreneurial forces are unleashed” as “the combination of accountability, responsibility, and more direct incentives take their natural course.” In other words, without the parent, the newly independent company can take advantage of capitalist forces to improve performance. Spinoffs: Looking for value So what do the experts look for in a good spinoff? According to Murray Stahl of Horizon Kinetics, there are four key characteristics to look for when a company spins off an unwanted subsidiary or division. First, a higher-margin business is spinning off a lower-margin business. Second, CEO movements. If the CEO of the larger company decides the best place to be is with the spinoff it’s, “a message to heed.” There’s also the capital structure of the SpinCo to consider. Too much debt dumped on the SpinCo from the parent can be a burden that haunts the company and strangles growth. That said, if figures show that the debt can be paid down over time, this creates an opportunity, like a publicly-traded leveraged buyout, according to Murray Stahl. And the last spinoff situation that creates an opportunity for profit is the very small spinoff that those engaged in industrial-scale money management are unable or unwilling to own (market cap Scalper1 News
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