Topic: Dividend Stocks

We think adding a spinoff strategy to your overall investment approach will pay off for you in a big way

April 22, 2020|by Scott Clayton

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Use a spinoff strategy to target investments that are often highly undervalued and come with lot of portfolio-building power

A spin off strategy can lead you to profitable investments and a portfolio boost.

When a company carries out a spin off, it sets up one of its subsidiaries or divisions as a separate publicly listed firm, then hands out shares in the new company to its own shareholders. It may hand out the shares as a special dividend or give its investors an opportunity to swap shares of the parent company for the shares of the newly established spinoff.

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Target a spinoff strategy to unlock hidden value in a company

One of the ways a company can try to unlock its own hidden value is by creating a separate, publicly listed company out of a subsidiary. It can either then opt to hand  its shares in the new company to its investors or it could first sell a portion of the shares to the public, most likely through an initial public offering, before handing the remaining shares to its own investors.

When the parent company first starts by selling a portion of the new company to the public, it does so to establish a market and a following among investors. That way, by the time of the spinoff, stock in the new company may be liquid enough to be sold relatively easily, or retained with some confidence as a worthwhile investment.

In our experience, and in most academic studies of the subject, both the parent and the new company created by the spinoff benefit: they generally do better than comparable companies for at least several years after the spinoff takes place.

Here are 4 reasons why a spinoff strategy should pay off for investors

• More flexibility. Spinning off unwanted assets lets parent-company managers focus on the part of their business they want to retain. Usually they hold on to the part best suited to their talents.
• Spinoffs are born with the proverbial “silver spoon.” Parent companies may devote great effort to ensuring they have adequate finances and strong management. They want the spin off to succeed, for their own prestige, and because they want spun-off bargain stocks to benefit their shareholders.
• Spun-off shares often take off after an initial slump. Many investors routinely dump stock they receive in a spinoff. They may only get a handful of shares — perhaps one for each 10 shares they own. They may have little familiarity with the shares, and coverage by brokerage analysts and the press is often minimal at first. But after this initial slump, these spun-off bargain stocks generally go on to outperform the market as a whole.
• Spinoffs may facilitate takeovers. Spun-off stocks are typically pure plays that are attractive to buyers, and have market caps that make them affordable

Use a spin-off strategy to improve the performance of your investment portfolio

The above-average performance for spinoffs makes sense for a couple of reasons.

First, corporate spinoffs involve a lot of work and legal fees. The parent will only spin off the unwanted subsidiary if it can’t sell the stock for what it feels it’s worth. That’s why companies only have an incentive to do spinoffs under two sets of favourable conditions: When they feel it isn’t a good time to sell (which often means it’s a good time for investors to buy); or when they feel the assets they plan to spin off will be worth substantially more in the future, possibly within a few years.

Second, company managers naturally prefer to acquire or expand their assets, not get rid of them. Getting rid of assets reduces a company’s total potential profit, which reduces the funds it has available to pay its managers. The management of a parent company will only hand out a subsidiary to its own investors if it’s fairly confident that the subsidiary, and the parent, will be better off after the spinoff than before.

Find out how you can add to you profit even more from a spinoff strategy with takeovers

Here’s a look at some of the key factors that enhance a spinoff’s takeover appeal. We use these factors to calculate our TSI Takeover Target Rating:

• General profitability, with low debt.
• Hidden assets such as a strong customer base, real estate, or well-known brand names.
• The absence of a major shareholder and little regulatory or anti-trust constraints.
• A total market value that makes the spin off a manageable purchase for a major competitor.
• Top-quality, but underperforming, assets. Prospective buyers within an industry look at a spin off company’s poor management or the lack of financial resources limiting its growth as an opportunity for a big profit boost.

Those following our Successful Investor approach have had great success with spinoff investing over the years. That’s especially true of the many spinoffs we have recommended that have gone up after they began trading, and have later attracted a takeover bid at a substantial premium over the market price.

Use our three-part Successful Investor approach to develop a profitable overall portfolio strategy

• Hold mostly high-quality, dividend-paying stocks.
• Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
• Downplay or stay out of stocks in the broker/media limelight.

Spinoffs have signficant potential for profit, yet are often unpopular with the investors who receive them. What spinoff shares have you received and how long did it take for you to recognize their value?