STOCK TALK: Sizing Up Spinoffs
December 18, 2006
Spinoffs rarely generate much excitement among the investment community. The main reason, perhaps, is that share prices of companies that have been spun off or carved out often perform poorly immediately after they begin trading. However, longer-term, spinoffs often perform well and one new exchange-traded fund [ETF] gives investors a new way to participate in the outperformance of this unique asset class.
A spinoff occurs when a company distributes shares of one of its subsidiaries to its existing stockholders. A conglomerate might choose to spinoff a business segment in order to focus more attention on other activities. For example, in order to concentrate on its credit-card business, American Express (AXP) recently split off its Ameriprise Financial (AMP) wealth management unit.
Sometimes, a company will implement a partial spinoff. With the so-called “carve out,” the company distributes only a minority stake in the subsidiary, but keeps control of the rest. A carve out might be initiated in order to raise capital or if the company feels that investors are not valuing the subsidiary properly as part of the parent firm. In other words, the parent company believes they can extract more value from the subsidiary by spinning it off.
Spinoffs often perform poorly immediately after they begin trading. One reason, perhaps, is due to the fact that many shareholders might choose to sell their stake in the new company and keep only their remaining position in the core business. Others believe that spinoffs don’t perform well because there is a negative stigma associated with them. That is, the subsidiaries are viewed negatively as troubled businesses that are being purged by their parent companies.
Yet, creators of one new exchange-traded fund believe that spinoffs are worth owning for the long-term. The Claymore/Clear Spin-Off ETF (CSD) began trading on the American Stock Exchange last week. The fund holds 40 spinoffs, with no one company accounting for more than 5% of the fund. New companies must have six months of trading history before being added, which reflects the fact that spinoffs don’t perform well right off the bat.
Longer-term, however, shares of carve outs and spinoffs can perform well. According to a recent MarketWatch story [“Spin Cycle,” by John Spence, December 18, 2006], which cited a February 2006 Lehman Brothers research report, “the average two year gain on spinoffs from 2000 to 2005 was 45% higher than the stock market as measured by the S&P 500 Index.”
The reason for the strong performance is not entirely known, but some speculate that, once free of the parent company, management within the spinoff company has better control and a greater financial incentive to grow earnings. As a result, the shares tend to perform well in the year immediately following the spinoff. Apparently, the folks at Claymore believe the trend can continue and the new fund, which now trades under the ticker symbol CSD, can be used as a helpful barometer for gauging how this unique asset class is performing.
Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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