The idea of the spin-off is perhaps more readily associated with the world of television – from Frasier and Melrose Place to Better Call Saul and a federation’s worth of Star Trek franchises – but it is also an integral part of finance.
For reasons we will consider shortly, we take a great interest in spin-offs, here on The Value Perspective (and yes, for the rest of this piece, we will be talking about companies, not TV shows).
This interest meant our attention was caught by an article in the Wall Street Journal, Break up and die: Spin-off fever can’t last forever, which argued towards the end of last year the “current frenzy” for breaking up large companies had “a top-of-the-market quality”. “When the music stops,” the piece continued, “spin-offs may stop spinning”.
The thrust of the article was not that spin-offs were a bad thing – indeed it flagged two academic papers supporting the view companies spun out of larger businesses tend to make money for their investors.
The piece did go on to argue, however, that spin-offs fare badly “when markets seize up”, such as the crash of 2008 and the eurozone debt crisis of 2011 – and, by implication, at some point in the not-too-distant future.
Here on The Value Perspective, we have never professed any insights into the future, not-too-distant or otherwise, but we do believe very strongly that corporate ‘events’, such as the spinning-off of a business, repay close attention by value investors.
Mauboussin is hopeful
Indeed, when he visited Schroders last year, Michael Mauboussin (the Wall Street Investment Strategist) highlighted spin-offs as one of the few areas investors could still be hopeful of finding outperforming ideas.
Mauboussin, who is an investor our team has a great deal of time and respect for, pointed us towards another academic paper, Value creation through spin-offs: A review of the empirical evidence (2008), which said it had uncovered “a significantly positive average abnormal return” of just over 3% being generated by corporate spin-off situations (past performance, of course, having no bearing on future performance).
Greenblatt is postive on spin-offs
Very early on in his insightful, if offbeat, investment primer from 1997, You Can Be A Stock Market Genius, US fund manager Joel Greenblatt devotes a whole chapter to spin-offs.
After also making the point spin-offs tend to beat the broader market, he writes that “picking your spots within the spin-off market can result in even better results” and “certain characteristics point to an exceptional spin-off opportunity”.
These include the fact “insiders want the spin-off”, which ties in with one of the attractions of spin-offs from an investment point of view – that their managers often have good, long-term incentives for the business to thrive and their interests are closely aligned with those of shareholders.
Other positives include that spin-offs tend to be smaller and thus more focused businesses that receive less coverage from company analysts.
On a topical note, potential spin-offs seem likely to be a key consideration as Melrose pursues the £7.4bn offer it announced last week for UK engineering giant GKN – the UK’s largest hostile takeover bid since Kraft targeted Cadbury in 2009.
Rather than speculate on the future, however, we will again look to the past for our preferred spin-off example – South32, which demerged from miner BHP Billiton in May 2015.
Over the rest of that year, South32 saw its share price halve, with the wider market arguably less than impressed by what the company was mining, not least so-called ‘dirty coal’, and where it was mining it – for example, Colombia and South Africa.
Furthermore, falling commodity prices meant this was a less profitable period for the mining sector, which may or may not have influenced BHP’s thinking in the first place.
Since the start of 2016, however, South32’s share price has more than quadrupled – adding further to the argument investors should pay close attention when a company announces it is spinning off part of its business.
Success is never a given but that should not stop investors searching for the equivalent of the one-minute cartoon slot spun out of The Tracy Ullman Show almost 30 years ago. It became The Simpsons.