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Spin-Off

Spin-offs involve distributing to shareholders a subsidiary or division, which usually does not have synergies with the core parent company. Normally, these are non-core and/or under-performing business units. Itís an easy way for a company to reduce cost and eliminate low profit margin segments, thus improving the consolidated margins on the remaining businesses. Additionally, shedding weaker divisions refocuses managementís attention on its main business. The resulting higher margin business may make favorable impressions on the stock analysts and investment bankers, resulting in higher valuations for the parent company. 

The newly created spin-off may also benefit by not being constrained by the bureaucracy of a larger parent company, and might become more entrepreneurial and profitable. When the shares are initially distributed as a new public company, however, these issues may not meet the portfolio criteria of many investors, and may be sold, sometimes regardless of price. One may also wind up with only a small number of shares, and the securities might become more of a nuisance to hold, rather than a valuable asset. Additionally, since stock analysts can only cover a dozen or so stocks at one time, these companies may be left with no coverage. This culmination of events leads to initial selling pressure on the stock. The investment strategy should be to wait until the selling subsides and the price stabilizes at its fair value, before making a decision. Additionally, be aware of instances where management loads up the spin-off with debt, making it difficult for the new company to make a fair return going forward for its new investors.   

There are also a few situations where a companyís mix of businesses is confusing to the investment community, resulting in a total market value that is lower than the sum of the individual businesses. This is the same issue as the drawbacks of the conglomerates in the 1960ís. Normally, in these situations, the parent company can either have a full or partial distribution of certain divisions or subsidiaries.

 

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