Topic: Spinoffs

What is a spinoff company? An investment opportunity that can supercharge your investment gains

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What is a spinoff company and how can it impact the value of your investment portfolio? When a company creates a spinoff, it hands out shares in that company to its shareholders, typically providing substantial benefits to investors in the process.

A spinoff takes place when a company decides to get rid of a portion of its asset base, possibly because it wants to focus its activities elsewhere, but is unable to sell the assets for a price that it feels reflects their value. Instead, the parent company sets the assets up as a separate company, then hands out shares in that publicly listed firm to its current investors.

What is a spinoff company worth after the spinoff has taken place? Typically more than most investors realize, unless they are value investors with spinoff experience.

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What is a spinoff company valued at? Theoretically, it’s valuable enough to attract savvy investors

The management of a parent company will only spin off the unwanted business if it’s fairly confident that this will pay off for shareholders in the long term, if not in the short. Generally, the parent company guesses right.

Companies that offer spinoffs do so when they feel it isn’t a good time to sell, and that probably means it’s a good time for investors to buy.

What is a spinoff company good for? Well, for one, attracting takeover bids

Spinoff companies also tend to attract big takeover offers. When an acquiring company makes a bid to assume control of a target company, it often pays a high price to buy a majority stake. Takeovers consistently offer a windfall to investors holding the shares of the target stock.

Both spinoffs and parents experience an unusually high incidence of takeovers, according to a number of studies.

Some takeovers work out well for the buyers, of course. This doesn’t diminish the value for the sellers.

What is a spinoff company? An investment to keep looking out for

It pays to follow spinoff opportunities wherever you find them.

Spinoffs generally work out well over a period of several years for both the spun-off stock and its parent. As mentioned earlier, the management of a parent company will only hand out shares in a subsidiary to its own investors if it’s fairly confident that the subsidiary, and the parent, will be better off after the spinoff than before.

Parent companies may devote great effort to ensuring that the spinoff has adequate finances and strong management. They want the spinoff to succeed, for their own prestige, and because they want the spun-off stock to benefit its shareholders.

Furthermore, spinoffs involve a lot of work and legal fees. That’s why companies only have an incentive to implement spinoffs under favourable conditions. For instance, when they feel the assets they plan to spin off will be worth substantially for their shareholders more in the future, possibly within a few years.

Bonus Tip: Takeovers and a growth-by-acquisition strategy

Takeovers are more likely to succeed when the buyer is already a successful company and is under no pressure to buy anything. That way, the buyer can take its time and wait for a truly attractive, low-risk opportunity to come along.

A growth by acquisition strategy is inherently risky. It’s a little like buying new stock issues.

These acquisitions generally come on the market when it’s a good time to sell. That may not be, and often isn’t, a good time to buy. Insiders and managers at the selling company know a lot more than the buyers about the company itself, and its business strengths and weaknesses.

If a takeover starts to falter, well-managed companies are likely to cut their losses while there is still some value to salvage.

The lesson here is that major, successful, well-managed companies do succeed in growth by acquisitions. But they use them as a tool for pursuing a core business, rather than making acquisitions the core of their business.

A growth by acquisition strategy isn’t foolproof; even the best managed companies stumble and fail. The best companies cut the risk by only making takeovers that help expand their core business. They are willing to get out, even at a loss, when they see an exit as the smart thing to do.

That’s one more reason why, in our publications and portfolio management service, we focus on high-quality, well-established companies. They make fewer takeover blunders. When they do make mistakes, they tend to recognize them earlier, and cut their losses before they reach catastrophic levels.

Do you think that companies spinning off real estate investment trusts (REITs) assets are contributing to corporate tax base erosion?

Have you invested in a spinoff that ended up failing? What do you think would have helped it succeed?


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