Spin-offs often result in a higher aggregate value for the constituent pieces. A spin-off occurs when a parent firm distributes shares of a subsidiary to the parent’s shareholders (often tax-free). Numerous academic studies have demonstrated that spin-offs outperform the overall market by a large margin. Spin-offs, as a group, outperform the broader stock market. During the past 14 years (from Dec. 21. 2002 to Dec. 30, 2016) the Bloomberg U.S. Spun-Off Index returned 714%, while the S&P 500 Index returned 155%.
Many diversified companies are electing to spin-off parts of their business, finding that this restructuring technique can create significant value for shareholders. There were 35 spin-offs in 2016 (worth about $100 billion in initial market value). The Spin-Off Index nearly doubled the market return last year (23.2% versus 12.0% for S&P 500).
The rational for spin-offs varies. Some companies want to get rid of a weak or low-margin division that is detracting attention from the parent. Other companies seek to highlight the attributes of a desirable unit whose full value may not be reflected in the parent’s stock price. Whatever the underlying motivation for spin-offs, they tend to do well.
Why do spin-offs prosper? Much of the impressive performance comes from the altered dynamics of the spun-off business and its parent. Spin-offs do well partly because when a business and its management are freed from a large corporate entity, pent-up entrepreneurial forces are unleased. The combination of accountability, responsibility and more direct incentives take their natural course. Managers have greater freedom to pursue new ventures, streamline production and pare overhead. After the spin-off, stock options can more directly compensate management of the new company. This often leads to improved operating performance over time. When one reconstitutes the parent and spin-off after a one- to two-year period, often outstanding overall returns are observed. Below are the top 15 spin-offs from 2016 (see “Tops in spins”).
Joe Cornell, Spin-Off Research