What follows are excepts from two academic studies on spin-offs. Spin-offs are special situations whereby a company spins-off an asset in a tax free distribution to its shareholders. Spin-offs are thought to have predictive attribute of outperformance due to structural factors.
A spin-off study – Chris Mayer (2005)
Spinoff Companies: Four Reasons Companies Spin Off
But before I tackle the reasons why this apparent inefficiency exists, let us consider the various reasons why companies engage in spinoffs at all:
1. To spinoff an unrelated business. Big unwieldy conglomerates that are involved in everything from insurance to restaurants may decide to separate an unrelated business to unlock the value in that business.
2. To separate a “bad business” from a “good business.” Sometimes a company with a profitable core of operations will spin off a laggard that is draining resources and management attention from the main group. Once separated, each of the businesses can stand on their own merits, often to the benefit of both.
3. To unload debt and/or other liabilities. Sometimes a spinoff will be loaded up with debt, freeing the parent company but leaving an overleveraged business in its wake. The spinoffs that have failed have often been of this kind. However, this maneuver can be lucrative for the parent company, as you might imagine.
4. To take advantage of tax benefits. A spinoff can qualify as a tax-free event and may be the most efficient way to pass value on to shareholders. If the company were sold outright, for example, the cash distributed to shareholders would be taxable. There are sound economic reasons for spinoffs, and this may explain their initial outperformance.
Think about it: You have a new company with a new, dedicated management team that is likely to be highly motivated. As Greenblatt writes, “Pent-up entrepreneurial forces are unleashed. The combination of accountability, responsibility and more direct incentives take their natural course.”
Curiously enough, as Greenblatt points out, the biggest gains from spinoffs often came in the second year, not the first. This indicates that perhaps it takes some time for the changes to kick in and deliver tangible results.
In Spinoffs, a Chance to Jettison Liabilities – Davidoff (2012)
“A spinoff is a product of Wall Street math that says one plus one can equal three. Yet as shareholders ofTime Warner may be about to find out, it can also be all about subtraction, as a company ditches an unwanted business, in this case, magazines.
The business argument for a spinoff is typically that a separation of the assets allows both the former parent and the newly independent company to be better run, freeing management to take bolder steps with the new company. And because Wall Street is a place where magic works, the market will recognize this, giving each of the separated companies a higher price.
There is evidence of this effect. Studies of spinoffs have found that they produce short-term gains, although these gains evaporate over the long term.”