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WHAT IS A SPIN-OFF

A spin-off occurs when a new independent company is created from an existing business division of a parent company. Shares of the spin-off company are issued to existing shareholders of the parent company. Effectively, the shareholder retains ownership interest in both the parent company and the spin-off company.





Typically this occurs when the business of the smaller spinoff company is not the core business of the parent company. Spinning off improves focus for both the parent company and the spin-off company.


SPIN-OFF SUPPLY AND DEMAND

Investors receive shares of a spinoff from a parent company whether they want the shares or not. In some ways, spinoff shares are like leftover chocolate from a larger box of chocolate. A certain investor might not like the flavour of the remaining chocolate (licorice flavour) and would throw out the remainder. However, someone else might like that flavour and it can be obtained at a bargain due to the oversupply.





There are a number of structural reasons why there can be indiscriminate selling and mispricing:

  • Institutions may sell it for reasons other than their investment merits.

    • The spinoff may not be related to the primary business and was not the main reason for owning the parent company

    • The market cap of the spin off does not fit the mandate.

  • There is no buying pressure to promote the spinoff, unlike an IPO, to offset selling pressure.
Another point to look at is whether company insiders are holding shares in the spinoff company, and if they are trying to increase their ownership.


SUM-OF-THE-PARTS VALUATION FOR SPIN-OFFS

Some parent companies continue to hold ownership in the spin-off companies. Sometimes part of the company can be valued based on the publicly traded price of the spinoff, and the remaining portion of the parent company may be mispriced. This can occur particularly when there is a complicated division or an extremely unrelated business.