When a company is spinning off part of its business to shareholders, what's the best move to mak♛e? Do you keep stocks in the parent company, in the spin-off, or both?

The question comes up a lot. Between 2021 and 2023, there were 677 spin-offs of public companies, including major brands like Kellogg and General Electric. However, these deals don't always create new value. Read on to find out what to do when companies split.

The Spin on Spin-offs

In a pure spin-off, a company distributes 100% of its ownership interest in a unit as a 澳洲幸运5官方开奖结果体彩网:stock dividend to existing shareholders. It's a tax-free method of divestiture that usually helps bo🌜th the parent and unit achieve better results as separa🦩te and more highly-valued entities.

Conventional wisdom, as well as historical evidence, suggests that spin-offs and parents both out-perform the market, with the edge going to spin-offs. A commonly cited study in The Journal of Financial Economics found "significantly positive" returns for both spin-offs and their parent companies over the three years after separation when compared to the market as a whole.

However, it's less clear whether these benefits are due to improved performance by spun-off businesses, or due to other market actors. Spin-offs can be attractive targets for acquisition by other companies, which can raise the stock price prior to a takeover. The same study in the Journal of Financial Economics found that spin-offs and their parents have "an unusually high level of takeover activity" and attributed the excess performance to firms involved in takeovers.

A Second View

It's also not clear that the expectations of future profits continue to hold out in contemporary markets. Some studies are decidedly mixed on the issue of whether spin-offs provide any long-term advantage.

Research by the Boyar Value Group found that over the ten years from 2010 to 2020, stock spin-offs underperformed the S&P 500 by about 2.7%. According to the researchers, this may be partially due to a changing market for spin-offs: Companies are under more pressure from their shareholders, and they are more willing to spin-off underperforming divisions as separate companies rather than invest in these assets.

What Keeps Spin-Offs Turning

Spin-offs may perform well for a few reasons. Management teams at the spin-offs have grea🌠ter incentive to produce, due to their generous stock options awards and stock holdings. They also have greater freedom to start new ventures, rationalize operations, and trim overhead. Meanwhileꦆ, management teams at parent companies can focus more on core businesses.

Further, spin-of⭕fs can also be attractive to speculators seeking to benefit from the split. This can have a self-fulfilling effect if a large number of investors buy stock in the parent company before the di🐽vision takes effect. Stock valuations for both companies may also benefit from investors who prefer focused and pure-play companies.

A 2022 study of 350 spin-offs by the Harvard Business Review found that about half of spin-offs failed to create any new shareholder value, and 25% actually lost shareholder value. However, those that performed well did so exceptionally: the top-performing quartile of separations increased their combined market capitalization by about 75% within two years of separation.

This may be because a successful spin-off is difficult to execute. Many companies "doom their separations from the start," according to the authors, because they "assume the mere act of spinning off a business is sufficient to achieve a higher multiple, and they define success shortsightedly as getting to day one as fast as possible."

In contrast, successful spin-offs have well-defined separation and transition plans, even before the change is announced. "In our study, we found that the existence of a clear and robust separation thesis was the single-biggest difference between top-quartile and bottom-quartile separations," they wrote.

Why Spin-Offs Are More Volatile

Still, spin-off stocks come with a couple of caveats. First, they are more volatile. With their smaller capitalization and 🍨financial capacities, they tend to be higher beta stocks that underperform in weak markets and outperform in strong markets. As such, spin-off stocks may be better to own during a bul✨l market than during a bear.

Seco🧜nd, spin-off stocks often sell-off in the months immediately following the restructuring. Giving shares in a spin-off to existing shareholders is not a particularly efficient way to distribute stock since the shareholders are primarily interested in the parent company. Index funds will also sell the company since the new company is not in the index.ꦏ Other institutions will sell because the spin-off does not fit with its mandates. It may be too small or have no dividend, or lack the history that the fund uses to make its choices.

In many cases, the immediate dip in spin-off stock prices is replaced by strength over the next two to three years. So, an investor planning to keep the spin-off may have to wait it out.

Evaluating Individual Spin-offs

William Mitchell, a parter at and former publisher of Spin-off & Reorg Profiles, says it's essential to "deduce the reason for separation," which can be done by comparing the pro forma balance sheet and income statements of🌳 the spin-off and parent. The🎶 first thing to check is debt levels and the allocation of other liabilities and troubled assets (such as real estate in 2008).

For example, a spin-off coul💟d end up over-leveraged because the parent may be doing a leveraged recapitalization. In other words, the spin-off is loaded up 🦄with debt and the proceeds are being pocketed by the parent.

Another important factor for Mitchell to study is the return on capital employed, which involves taking the ratio of operating income to net working capi🉐tal less cash. A spin-off (or parent) with a low reading on this measure may not have much of a strategic advantage in its line of business.

Example of Spin-Offs

One example of a successful spin-off is Kellanova, formerly known as Kellogg Co. The global cereal and snacking company announced in 2022 that it would split into three independent, publicly-traded companies. The cereals and plant-based foods divisions would be spun off as new companies, while the parent company retained the frozen foods and snacking brands.

Ultimately, the company decided not to sell the plant-based foods division, but the spin-off did allow Kellogg to divest itself from the stagnating breakfast cereal and focus on the more profitable snacking brands. The divorce was finalized on Oct. 2, 2023: The North American cereal business began trading as WK Kellogg(KLG) and the larger snacking business was renamed Kellanova (K).

Investors received one share of WK Kellogg for every four shares they owned of Kellogg's before the split. 澳洲幸运5官方开奖结果体彩网:Both companies saw thei🌺r shares tumble immediately following the split, although performance improved over the following months: WK Kellogg's stock price rose from about $10 to a high above $23 the following spring. Kellanova's stock price rose from about $50 on the date of separation to around $60 the following summer.

The separation also helped streamline the two businesses, making them more attractive prospects for acquisition. In August 2024, Mars, Inc. announced its plans to purchase Kellanova at $83.50 per share. An investor in the original Kellogg's—valued around $55 per share before the spinoff—would have realized about $87 in shareholder value if they kept both shares.

The Bottom Line

Spin-offs have historically been attractive prospects, providing exposure to two different companies after the split. A well-execu💯ted spin-off can provide a significant boost in shareholder value, but investors should be cautious about spin-offs that are poorly planned or loaded with𝔉 extra debt.