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The Reason Investors Love Spinoffs: Juicier Returns

Posted by Joe Cornell, CFA on Wed, Oct 11, 2017 @ 10:10 AM

Joe Cornell, Spin-Off Advisors, Spin-Off Research

By Miriam Gottfried and Thomas Gryta
Oct. 10, 2017 8:16 p.m. ET

Spun-off companies tend to perform better than the broader market and—often—than their former parent

Among corporate executives, spinoffs of divisions have come in and out of favor over the years, but with one group they have been a steady crowd-pleaser: investors.

Pfizer Inc. PFE -0.12% and Honeywell International Inc. HON -0.31% on Tuesday announced plans to hive off major business units in an effort to sharpen the focus on their core operations.

The moves served as a reminder that even though such activity has slowed, handing businesses to shareholders remains a popular tool as company executives, often besieged by activist investors, find it harder to justify a vast sweep of businesses and pivot toward leaner and more focused operations.

Companies use spinoffs—the act of turning a unit into a separate, publicly traded company by issuing newly created stock—to simplify their operations and shed unrelated businesses while avoiding tax bills that sales of divisions often entail. For investors, the appeal of spinoffs lies in their long history of outperforming the broader market, particularly in the years immediately following separation from a corporate parent.

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Including dividends, the S&P U.S. Spin-Off Index has outperformed the S&P 500 by nearly 190 percentage points over the past decade. The index is composed of companies with market capitalizations of more than $1 billion that have been separated out within the previous four years. Companies leave the index after that time has passed.

“These companies go from being redheaded stepchild of some conglomerate where they have to go and beg for money to being able to allocate capital as they choose,” said Joe Cornell, founding principal of research firm Spin-Off Advisors LLC.

Spun-off companies also tend to have management teams that are better incentivized, Mr. Cornell said. Hedge-fund and mutual-fund managers would rather invest in a specific business than a collection of businesses, and will assign a higher value to a stand-alone business, he said. Spinoffs can also help the parent company be valued by investors at a higher multiple of earnings.

That helps explain why activists often push companies to break up or spin off one of their divisions. Hedge fund Third Point pressured Honeywell to spin off its aerospace unit in April. On Tuesday, the industrial heavyweight instead said it would cleave off about 20% of its revenue by spinning off its business that makes thermostats for the home and a unit that focuses on automobile turbochargers. Together, analysts estimate the businesses could be worth as much as $10 billion.

Honeywell Chief Executive Darius Adamczyk said in an interview Tuesday that taxes were a key consideration in the decision to pursue the spinoffs. The company is open to acquisition offers for the units, but any price would have to exceed its projection of the spinoff value, he said.

This year, Elliott Management Corp. pushed mining giant BHP PLC to spin off its U.S. oil-and-gas units into a separate publicly traded company. BHP said in August it would seek to unload the unit.

Still, such activity has been depressed lately, in part as uncertainty over tax policy and other matters in Washington has put a damper on overall deal numbers. After spinoff volume surged in 2014 and 2015, there have been just 10 such completed deals so far in 2017—on track for the lowest annual level since Dealogic began tracking the data in 1995.

But investors’ eagerness for such moves hasn’t diminished, as the performance of some recent high-profile spinoffs attests. In many cases, they have vastly outperformed the shares of their former parents.

PayPal Holdings Inc.’s share-price performance has bested that of eBay Inc. by more than 30 percentage points, including dividends, since the payment firm’s July 2015 spinoff. Similarly, shares of ZoetisInc. have outperformed those of Pfizer by nearly 60 percentage points, including dividends, since the maker of pet medications was spun out of the pharmaceutical giant in February 2013.

Pfizer now hopes to hand its shareholders another gift, announcing Tuesday it is exploring a sale or spinoff of its consumer-healthcare business, home to well-known brands such as Advil and ChapStick. Analysts estimate the business could be worth upward of $10 billion. Pfizer said the consumer unit’s value could “be more fully realized outside the company.”

There are notable disappointments among recent spinoffs. Shares of HP Inc., which makes printers and computers, have outperformed Hewlett Packard Enterprise , a provider of IT services, since the latter was spun off in October 2015. The hope was that the spinoff would have room to grow without the profitable, but declining, printer business to weigh it down. Shares of HP Enterprise have risen 56%, including dividends, since then—versus a 68% gain for shares of HP.

Activist investor Jana Partners LLC pushed oil-and-gas services company Oil States International Inc. to spin off Civeo Corp. , a lodging company for oil-field workers, just months before a downturn in energy prices sent Civeo’s shares tumbling in late 2014.

Shares of News Corp , the owner of Wall Street Journal parent company Dow Jones, have underperformed those of 21st Century Fox Inc. —the original parent company—since the two companies split in June 2013.

There are also plenty of examples of companies with a wide scope of operations that continue to prosper, like Amazon.com Inc. and Berkshire Hathaway Inc.

One group that benefits whether spinoff activity is ebbing or flowing, according to Mr. Cornell of Spin-Off Advisors: the bankers that reap hefty fees from arranging deals.

“You get five years of unbundling, then there’s a lot of merger activity, and bankers start saying ‘hey this asset would make a lot of sense for you.’ ”

—David Benoit 
contributed to this article.

Write to Miriam Gottfried at Miriam.Gottfried@wsj.com and Thomas Gryta at thomas.gryta@wsj.com

Appeared in the October 11, 2017, print edition as 'Companies Chase Spinoff Bump.'

https://www.youtube.com/watch?v=MmzJi4ThBeo&feature=youtu.be

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Spin-Off Research is published by Spin-Off Advisors, LLC. Spin-Off Research is a subscription-based service for Professional and Institutional Investors.  Blog entries are delayed.  Spin-Off Research subscriber-base receive the spinoff report at time of press via Email Bulletins.  To learn more about becoming a subscriber, please contact us. Spin-Off Advisors, LLC provides coverage on all US and major Global spinoffs, carve-outs and split-offs; Spin-Off Research published since March 1997.