I recently gave a presentation looking at Spinoffs and their historical large excess returns, looking at what factors seemed to be important to construct a portfolio of a subset of the spinoff industry. I thought it might be interesting for the more research-based investors among us.
A spin-off is when a company (parent) creates a new company by selling or distributing new shares of its existing business, it’s a type of divesture. (Investopedia paraphrase + some added info).
This subset of companies (both parent and child) seem to have outperformed the market consistently historically, and the child’s performance was phenomenal over the last half century.
(Purdue university study which was renewed and issue from 1993 journal of financial economics)
It was found those child companies (the spun-off company) really outperformed so it might be interesting for research-driven investors to know why this happens so consistently and how to profit from this phenomenom. Especially the excess return in the first three years is strong.
Explanation of outperformance
According to multiple papers and research articles it seems that the Congomerate discount is responsible for some of the outperformance.
Historically conglomerates trade at a ~10% discount to their pure play peers (Spin-offs: Tackling the Conglomerate Discount). Conglomerates (execpt those in Latin America and Japan) trade at a discount because they’re more inneficent, less transparent and don’t achieve all benefits for shareholders that they could. This largely is due to the diffrence in growth profiles of divisions and these must compete for limited capital, this results in high growth divisions finding themselves at a comparative disadvantage to the the larger and more established divisions within a conglomerate. This discount being priced in again could explain some of the outperformance during the initial three years after the spin off.
See figure below.
This discount has persisted (the 10 year period represented below is a very short time period in financial research which must be noted) and thus seems to support that conglomerates invest more ineffiecntly but have potential value to be unlocked.
When spinning of the child can allocate capital better, focus on it’s core business and be more transparent (in conglomerates there is division reporting but not to the detail as with which a public child would disclose). It can be said that (most) investors like higher returns on investment and transparency.
Fun fact: Spin-offs lead to an improved valuation multiple for the parent as well
(I’m very funny at parties)
Instead of putting a Warren Buffet concentration builds wealth I choose an interesting quote by Sun Tzu, there seem to be certain factors within spin-offs that improve performance as well let’s take a look!
Subsets of spinoffs
In research conducted by Matthew Semandeni and Alber Cannella found that continued ownership by the parent firm has a negative effect on the child firm market performance
The parent retains ownership because it believes the child stock will appreciate and therefore it has an interest in the child’s success, leading to a positive relationship between parent ownership and performance but the parent often retains the ownership to exert continued control over the child, and that this continued control would negatively affect performance as proved by M. Semandeni and A. Cannella.
Another interesting finding is that having either a board member or a chairman of the board from the parent firm has essentially the same positive effect on the child firm’s market performance. But having both a board member and chairman from parent has a negative effect.
The above is also related to control by the parent firm, it seems that a little bit spurs better performance but more has a negative result.
Also having ties form the parent when previously vertically integrated or horizontally related seems to have a positive effect on the child performance.
Just so you know:
Horizontal: same industry and at the same stage of production
Vertical: same industry but different production stage
There are a lot of ways to seperate bussines, as highlighed in the slide above, if you’re interested in the other strategies I would suggest you read Spin‐offs: Tackling the Conglomerate Discount (Ajay Khorana, Anil Shivdasani, Carsten Stendevad, Sergey Sanzhar, Citi) or find more research going into more depth on your topic of interest!
Bellow some of the spinoffs expected this year (VODs Vantage Towers already is next week)
Hope it was an interesting read and let me know what your thoughts are!
Note: I didn’t put links to the articles as a lot of people don’t have access to those databases so if you can’t find it yourself I can share the papers if you want
Spin‐offs: Tackling the Conglomerate Discount (Ajay Khorana, Anil Shivdasani, Carsten Stendevad, Sergey Sanzhar, Citi)
Spin-Off Performance: A Case of Overstated Expectations? (Carolyn Y. Woo, Gary E. Willard and Urs. S. Daellenbach)
Drivers of spin-off performance in industry clusters: Embodied knowledge or embedded firms? (Guido Buenstorf, Carla Costa)
How Spinoffs Shares Outperform the Market Index
7 Stock Spinoffs to Watch in 2021
Disclaimer: I own several spinoffs (although not recent ones) like Aperam, Abbvie and hold MRK directly which will spin off Organon. Also hold shares in Ecolab which split off Champion X