Spin-Offs In The Spotlight: The 'Spin-Cycle'

Investors and companies remain focused on ways to unlock shareholder value. Spin-offs are an old favorite for unlocking shareholder value. So far, nine spin-offs were completed in 2014 and another 17 new spin-offs were announced during the same period.  We expect an additional 40 spin-offs to be completed by the end of 2014, for a total of 49 in 2014.

Spin-Offs Explained

Spin-Offs are a relatively well-known form of corporate restructuring that has ramped up in recent years as a combined result of a move toward de-mergers and increased shareholder activism. While there are several different methods to structure a spin-off, the end result is the same: a subsidiary business is separated from its parent company via the creation of a new and independent entity. Typically, the shares of the subsidiary are distributed (tax-free) to existing shareholders of the parent company or sold to the public (in an IPO “carveout”).

In a traditional equity spin-off, the parent company distributes all of its equity ownership in a subsidiary company to existing shareholders in a tax-free dividend of the subsidiary’s newly traded stock. Once the spin is completed, the ownership structure of the spin-off and the parent company are identical. Shares are simply distributed to existing shareholders as a pro rata dividend.

In an equity carveout, the parent company sells a stake in the subsidiary company  (usually 20% or less) for cash proceeds in an IPO and often distributes the remaining interest to existing shareholders at a later date. Unlike a traditional spin-off, an equity carveout generates capital since shares in the subsidiary are sold to the public via an IPO.

Spin-Offs Outperform the Market

Investors like spin-offs because they prefer focused companies to diversified ones. Financial engineers like them because they are more tax efficient than a straight sell-off, which incur capital-gains tax. They also offer tasty returns. A wealth of academic research supports this assertion, even though studies may disagree as to the cause—variously citing factors such as more powerful incentives and greater freedom for management team; higher valuations because equity markets prefer pure play companies; and the premium that comes from the prospect that spin-offs can more readily be taken over.

One way to track the performance of spin-off companies is through the Guggenheim Spin-Off ETF (Symbol: CSD). The Guggenheim Spin-Off ETF is based on the Beacon Spin-Off Index, which is rebalanced semiannually. To be eligible for inclusion, a company must be spun-off 6 to 30 months prior to the rebalance date and trade on a major US exchange as common stock, ADR, or MLP. Both traditional spin-offs and carve-outs are considered for inclusion.  From this universe, Beacon Indexes selects up to 40 companies for inclusion.  Since the March 9^th, 2009 market bottom, the S&P 500 has generated a total return of 201%. The Guggenheim Spin-Off ETF has provided investors a total return of 379% over the same period.

Spin-Off Drivers 

The principal reasons often cited by companies for pursuing spin-offs include the following:

1. Enhanced business focus.  A spin-off will allow each business to focus on its own strategic and operational plans without diverting human and financial resources from the other business.
2. Business-appropriate capital structure.  A spin-off will enable each business to pursue the capital structure that is most appropriate for its business and strategy. Each business may have different capital requirements that may not be optimally addressed with a single capital structure. 
3. Distinct investment identity.  A spin-off will create distinct and targeted investment opportunities in each business. A more “pure-play” company may be considered more transparent and attractive to investors focused on a particular sector or growth strategy, thereby burning-off the “conglomerate discount” and enhancing the value of the business. 
4. Effectiveness of equity-based compensation.  A spin-off will increase the effectiveness of the equity-based compensation awarded to employees, officers and directors more directly to the performance of the business for which these individuals provide services. 
5. Use of equity as acquisition currency.  By creating a separately publicly traded stock, a spin-off will enhance the ability of the spun-off business to effect acquisitions using its stock as consideration.

Spin-Offs in the News

There were another handful of spin-offs announced in March. Healthcare giant Baxter International (BAX-$72.36, market cap $39 billion) will spin-off its biotech arm by the middle of 2015, leaving the parent focused on medical products and equipment. Chesapeake Energy (CHK-$26.65, market cap $18 billion) announced plans to spin-off its oilfield services business. The spin will be called Seventy Seven Energy FMC Corporation (FMC-$74.67, market cap $10 billion) announced that is will spin-off its Industrial minerals division, refocusing the parent on its agriculture, health and nutrition units. The split is expected to take place in early 2015. Hertz Global Holdings (HTZ-$25.90, market cap $11.5 billion) will spin-off its construction equipment rental business in early 2015. 

SINA Corp. (SINA-$52.19, market cap $3.5 billion) will carveout Weibo in an IPO this week. SINA is an Internet media company operating Chinese language destination sites.  Weibo is a Chinese micro blogging website and a leading social media platform in China.  Weibo expects to price the IPO in the range of $17 to $19 per American Depository Share (ADR). The pricing is expected to be announced on April 16 and the shares are expected to begin trading on the NASDAQ on April 17 under the ticker “WB”.   SINA will carve-out part 11% of Weibo in the IPO and retain 56.9%.  Alibaba will own 32% post IPO.  Each share of the parent (SINA) will have 1.74 shares of Weibo embedded post IPO (based on the midpoint price of $18). This suggests each share of SINA will have about $31 worth of Weibo (per SINA share) after the carve-out.

Spin-Off Research 

http://www.4shared.com/office/cO-Tw7cQce/The_Choice_of_Going_Public__1_.html