By Dani Burger | Bloomberg News | October 10, 2016
A favorite tool of activists for enhancing stock returns is working again after one of its roughest stretches of the bull market.
After a year in which spun-off shares languished, announced plans from the likes of Hewlett Packard Enterprise Co. and Procter & Gamble Co. have lifted returns from newly independent stocks more than twice as much as the S&P 500 Index’s in 2016.
Companies tracked by the Bloomberg Spinoff Index are up six of the last seven months and climbed 0.5 percent on Monday, while the S&P 500 also added 0.5 percent to 2,164.65 at 12:45 p.m. in New York.
The revival ends a yearlong dry spell in which a proliferation of spinoffs in struggling industries such as oil and raw materials turned sentiment against the tactic. A rebound in energy stocks and a flurry of separations in technology, this year’s second-best performing industry in the S&P 500, is spurring the turnaround.
“When there was a weaker market over the past year, there were more unknown factors -- there’s an unknown management team, their spinoff is a bad business, and there’s limited financial statements tied to these new companies,” said Jonathan Morgan, an analyst for Edge Consulting Group LLC, a Morristown, New Jersey-based research firm that analyzes spinoffs and special situations. “Now the risk appetite is growing for spinoffs and there are so many more interesting names coming up.”
In September, money manager TPG said it would invest in Intel Corp.’s cybersecurity spin-out in a deal that values the business at $4.2 billion. Intel shares have since climbed to the highest level since since the dot-com bubble. Last week, insurance giant MetLife Inc. gained more than 5 percent in two days after disclosing plans to carve out a retail subsidiary with $240 billion in assets that offers retirement products and other services.
Investors are rewarding all sides. This year, parent companies have gained an average 2.3 percent in the four weeks after making public their plans to spin off shares. That’s 1.5 percentage points more than the S&P 500 over the same time frame for the biggest spread since 2010, data compiled by Bloomberg show. Meanwhile, an index tracking child shares reached its highest level ever at the end of last month.
It was a different story altogether in 2015. Parent companies fell nearly 2 percentage points more than the S&P 500 a month after a spinoff was announced in the worst relative performance since 2011. Spinoffs dropped 2.7 percent in the worst year since 2011.
Energy BoostU.S. stocks rebounded from a weekly decline Monday, led by energy producers as a rally in crude bolstered optimism that the drag from weakness in oil will abate. Oil and gas companies in the S&P 500 were headed toward the highest in 15 months after Russian President Vladimir Putin said his country is willing to consider freezing or even cutting oil output in cooperation with OPEC.
The S&P 500’s advance reversed a 0.3 percent decline on Friday. The Dow Jones Industrial Average added 95.14 points, or 0.5 percent, to 18,335.63 today. The Nasdaq Composite Index increased 0.8 percent. West Texas Intermediate crude futures in New York rose 2.6 percent.
“The gains today could be because Putin has said that he’s willing to reduce output and freeze production to increase the price of oil,” said John Conlon, chief equity strategist at People’s United Wealth Management which oversees $5.5 billion. “The earnings season is now going to be grabbing attention for the next three weeks. The market is still betting that Hillary Clinton will win the election.”
Equities were rising Monday in the face of risks from U.S. elections to higher borrowing costs and corporate earnings in the final quarter of the year, with strategists saying a holiday rally is not in the cards. Stocks have gotten off to a rocky start in October, with the S&P 500 ending a three-week winning streak as recent economic data and hawkish comments by Fed officials boosted speculation of a rate increase by year-end. The benchmark is 1 percent below a record reached in August.
Technology companies make up the majority of those pursuing the spinoff strategy, with a total value of $9.7 billion within the Russell 3000, or an 119 percent increase from last year, data from Bloomberg show. Previously it was energy companies, looking to alleviate squeezed profit margins as the price of crude plummeted, said Joe Cornell, an analyst at Spin-Off Advisors LLC, an equity research firm in Chicago.
“If you look back to 2014, there were quite a few spinoffs of various energy names, and a lot of those did that at the wrong time when the price of energy was high,” Cornell said. “This year, the IPO market was cut in half, so the IPOs and IPO spinoffs that happened this year have been of higher quality.”
To be sure, there are still laggards among the bunch. After posting its worst quarterly loss in at least a quarter century, Occidental Petroleum Corp. said in February it would distribute its California business to stockholders in the form of a special dividend. It fell 2.8 percent in the month after announcing its spinoff while the S&P 500 gained 5.4 percent.
Even though profits look better this year, companies that pursue spinoffs tend to struggle with raising their margins when compared to U.S. companies as a whole, according Abhra Banerji, the director of quantitative research at Evercore ISI. That may have discouraged investors in the past, but in 2016, buying profitable companies hasn’t paid off. A strategy which owns companies with the most earnings momentum and shorts those with the least has fallen 4.3 percent year-to-date, data from Evercore ISI show.
“Low profitability and revenue growth companies have outperformed this year relative to the high profitability and revenue growth companies. This could be playing in to the out performance of spinoffs,” Banerji said. “If nothing, it is a good tailwind.”
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