How do spinoffs create value?

Value investing is the process of buying securities that are trading at prices well below their intrinsic value and then waiting for the market to discover the value and raise the price in line with the value. As per the legendary value investor Seth Klarman, securities market can throw up many opportunities for the savvy investor to buy securities at significant discount to the intrinsic value.

Management actions like spinoffs present two benefits. One, they help the market close the gap between the price and the value by giving shares directly to the investors. Two, they send a clear message that management is shareholder friendly. 

Market regularly throws Value Investing opportunities

One such opportunity arises when company decides to spinoff its subsidiary into a new company. In the chapter 10 of the book Margin of Safety Mr.Klarman discusses the value investing opportunities provided by spinoffs.

Spinoff is the distribution of shares of a subsidiary company to the shareholders of the parent company. Spinoffs help parent company to divest businesses that no longer fits strategic objective. The goal of spinoff is to create parts with a combined market value greater than the present whole.

They present attractive opportunity since immediately after Spinoff, the shares of the spun-off companies are bound to trade at low prices as markets discover their value. Many shareholders of the Spinoffs sell their shares quickly since they follow the decisions of the management of the parent company. Sometimes the shareholders sell the spun-off company because they know nothing about the new company. Large institutional investors will sell spinoffs since they may be too small for them. Index funds will sell spinoffs since they are not a part of the index they are tracking.

In case of spinoffs, as the shareholders dump the shares immediately after the spinoff, the share prices get significantly depressed. Unlike other securities, the selling is not because the sellers know something more than the buyers, in many cases, the selling happens because the sellers know nothing. 

Wall street do not follow spinoffs. The analysts following parent company may not follow spinoffs that are in different industry. Sometimes management wants to keep the share prices down. Another reason spinoffs are valuable in the initial stages is because there is an information lag. Sometime opportunities exist in the parent company shares and not in spinoffs.

In summary, Spinoffs present a great value investing opportunity due to the following reasons.

• Spinoffs help increase the market value of the group.
• Shareholders are ignorant and tend to dump shares
• Spunoff companies do not fit the strategic objective of the Institutional Investors and hence they dump the shares
• Management wants to keep the share prices low
• Not many analysts track spiinoffs

Spinoff opportunity is the most valuable in the first few weeks of trading.