Investing in the stock market offers multiple options and possibilities. One interesting investment option is the spin-off, a process in which a company separates a subsidiary to allow it to be listed independently. How do they work? Which have been the most famous in history? What returns do they provide?
A spin-off, also known as a demerger, is a process in which a parent company spins off one of its subsidiaries, making it an independent company that is listed separately. In this process, the parent company either sells new shares, distributes them to existing shareholders, or does a combination of both.
The shareholders of the parent company will automatically become owners of the new company. This process is called "divestiture” of the original company and aims to separate the business by listing it with a different financial structure and management team.
As the Corporate Finance Institute points out, there are various reasons why a spin-off might occur. These range from reducing costs to creating tax shields, and even entering a new industry while maintaining a close relationship with the new company. But, in general, the expectation is that this spin-off will generate a more profitable and valuable new company on its own than it would as part of the parent company. This, in turn, will also attract more capital for further growth.
Some famous spin-offs
Corporate spin-offs are filled with success stories, and spin-offs can be observed almost every year on both sides of the Atlantic. One of the most talked-about cases in recent years was the separation between eBay and PayPal. In 2002, eBay bought the online payment company, and thirteen years later, proceeded with a spin-off. From that moment until June 2022, PayPal doubled its stock market valuation.
Another notable case occurred in 2012, when Kraft Foods transitioned to Mondelez International for its business outside the U.S. U.S., Following this move, Mondelez surpassed $26 billion in annual turnover, while the Kraft Foods group merged with Kraft Heinz. But that’s not all: Mondelez’s current valuation—$89 billion—doubles that of Kraft Heinz, at $44 billion.
Is investing in spin-offs profitable?
The truth is that, in terms of profitability, these operations are often lucrative and tend to outperform benchmark indices. According to a study conducted by Purdue University, spin-offs that occurred between 2000 and 2013 outperformed market indices by more than 17% in their first 22 months of trading. Likewise, parent companies exceeded the market average by about 4% in their first 15 months.
Famed American investor and author Joel Greenblatt asserts that, historically, spin-offs have outperformed the S&P 500 by 10% annually in their first three years. In fact, the separation of business units (i.e., a spin-off) is the most common value-creation demand among activist shareholders. So much so that this demand was made in approximately 28% of activist campaigns from 2006 through the first quarter of 2023.
Switzerland, a winning formula
However, it's not all positive for spin-offs. According to a study by Boyar Research, companies that were spun off during the decade from 2010 to 2019 underperformed the S&P 500, averaging about -2.7% per year compared to the index.
While the overall trend over the past decade has been worse, the truth is that this same report highlights that spun-off companies that outperformed their benchmark index in the first year subsequently offered annual returns exceeding 20% compared to the index in the following periods. Similarly, stocks that underperformed in the first year continued to generate more modest returns, trailing the index by about 19%.
So, with all this data on the table, it can be stated that companies resulting from a spin-off tend to be profitable, in general terms, for investors and outperform the market, especially if they did so during their first year of trading.
