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5 Ways to Cash In on Spinoffs

Posted by Joe Cornell, CFA on Tue, May 29, 2012 @ 10:05 AM

Kiplinger's, spin off, spinoff, Joe Cornell, Joseph Cornell, Spin-Off Research

Kiplinger's | July 2012

By Kathy M. Kristof

You can often find bargains when companies jettison a division.

THERE ARE A FEW SURE THINGS in picking stocks. But if you want an investment that puts the odds in your favor, consider spinoffs.

When big companies split into pieces, the parts often become more valuable than the when they were combined. Studies conducted by a range of researchers, from JPMorgan to Penn State, have found similar results. For instance, a McKinsey study of 300 companies spun off between 1988 and 1998 found that during the two-year period following the separation , stocks of the new firms outpaced the market by an average of ten percentage points. Other studies found that both the parents and the new spinoffs outperformed market averages, although the percentages varied dramatically from study to study.

What makes the returns enviable, and what makes the statistics a little fuzzy, is the same-namely, spinoff are rare. Roughly 30 companies a year, on average, announce plans to peel off a piece of their business and plunk it into the hands of shareholders in the form of newly minted shares.

Once a company announces a spinoff, it can take a year or more to complete.

The plus side of rarity is that a spinoff, much like an artistic genius, can be misunderstood and neglected. Analysts often stop covering the parent company because a divestiture can change it so much, and it may take years before the spinoff attracts its own following. Moreover, institutional investors often dump the shares of the spinoff for reasons unrelated to the company's value or prospects. Managers of index funds, for instance, can't own shares in companies that are not in their index, and a spinoff is not likely to qualify. that kind of automatic selling can depress a spinoff's shares and create bargains for investors.

A good spinoff can also ignite the sort of entrepreneurial zeal that leads to better-than-average market returns. "If you have an asset that's not being managed or properly valued by the parent, it can make sense to let that piece of the company pursue its own destiny," says Joe Cornell, owner of Spin-Off Research, in Chicago. "The division goes from being a subsidiary, begging its parent for money and attention, to a separate entity with its own management, board and strategy. That cranks up the entrepreneurial feel, and improve the company's performance and stock."

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