Who We Are
What are Spin-Offs
What Are Spin-Offs?
In a pure spin-off, a parent company distributes 100% of its
ownership interests in a subsidiary operation as a dividend to its existing shareholders.
After the spin-off, there are two separate, publicly held firms that have exactly the same
shareholder base. This procedure stands in contrast to an initial public offering (IPO),
in which the parent company is actually selling (rather than giving away) some or all of
its ownership interests in a division. The spin-off process is a fundamentally inefficient
method of distributing stock to people who may not necessarily want it. For the most part,
investors were investing in the parent companies business. Once the shares are
distributed, often they are sold without regard to price or fundamental value. This tends
to depress the stock initially. In addition, institutions typically are sellers of
spin-off stocks for various reasons (too small, no dividend, no research, etc.). Index
funds are forced to sell the spin indiscriminately if the company is not included in a
particular index. This type of selling can create excellent opportunities for the astute
investor to uncover good businesses at favorable prices. Often, after the spin, freed from
a large corporate parent, pent-up entrepreneurial forces are unleashed. The combination of
accountability, responsibility, and more direct incentives (stock options) typically shows
up in the operating performance post spin.
Carve-outs (Partial Spin-Off)In this case, the parent corporation sells to the public an
interest of less than 20% in the new subsidiary in a SEC registered public offering (IPO)
for cash proceeds. Often, an IPO in which the parent company retains a majority interest
in the new company, may be a prelude to a spin-off of the remaining interests to existing
shareholders. Companies utilize a partial spin-off strategy for a number of reasons.
Sometimes a corporation may need to raise capital. Selling off a portion of a division
while still retaining control may be an attractive option for a company. At other times
the motivation for pursuing a partial spin-off is to highlight a particular
divisions true value to the marketplace. Its value may be masked when buried among
the parent companys other businesses. A separate stock price for the division
enables investors to value the division independently.
StubsPartial spin-off transactions occur when a corporation
distributes shares in a subsidiary to the public while retaining partial ownership. After
a subsidiary becomes publicly traded, it is possible to determine the market value of the
parent companys investment in the subsidiary. By subtracting the subsidiarys
per-share value from the parent companys per-share value, we will be able to isolate
the implied value of the parent companys core businesses known as the
"stub". The stubs trading value can be at times less than its intrinsic
value because the true business value of the stub becomes obscured. We try to identify
stub situations where the value is significantly in excess of its current implied value.
It is possible to synthetically create a stub investment by purchasing the parent
companys stock and shorting its underlying subsidiaries (the carveout). This
methodology allows investors to capture the unrealized value of the stub, while
simultaneously hedging market risk.
Companies create these
stocks to track the fortunes of one or more of their subsidiaries.
We view tracking stocks as distant cousins to spin-offs. Unlike a spin-off¾where
a division is separated from the parent, goes public, and has complete
autonomy financially and managerially form the parent company-tracking
stocks represent shares that are still joined at the hip to the parent
(there is no legal separation of the assets or liabilities).
The parent and tracking stock operate under one management team
and one board of directors, even though the tracking stock’s finances
are reported separately from the parent.
Companies issue tracking stocks to hopefully unlock value in
their underlying subsidiary. Tracking
stocks have some advantages (to the issuer) over spin-offs.
Issuing tracking stocks is always a tax-free procedure and if
either of the two units were losing money, the earnings from one would
offset the losses of the other for tax purposes.
Borrowing costs for the tracker are usually lower because it
relies on its parent’s higher credit rating.
Overhead costs are lower than if the two were separate.
If synergies exist between the parent and the tracker, there are
added benefits. As with
spin-offs, the biggest reason for issuing tracking stock is the
potential to goose the parent’s stock price.
Companies often feel that Wall Street analysts and investors
incorrectly value captive subsidiaries that are overshadowed by the
parent. So investment
bankers tell them that the creation of a tracking stock highlights
“pure-plays” that can be valued higher by the market. This may prompt separate analyst coverage, and entice a
different set of shareholders for the company.
Tracking deals are our least favorite restructuring technique. Tracking stocks have inferior shareholder rights and the
potential for serious conflict of interest issues. We believe the biggest drawback with tracking issues is that
they are immune from takeovers. From
an investor’s point of view, we would prefer to “own the thing that
owns the thing”.