What Is a Spinoff?
When a parent company gives its shareholders ownership stakes in a subsidiary or business unit, the result is a new, independent company known as a spinoff. It’s a form of selling off an asset.
When a company spins off a division, it does so with the hope that the new company will be more valuable to investors than the original division was to the parent company. The term “spinoff” can also refer to “spinout” or “starburst.”
KEY PHRASES
- When a parent company gives its shareholders ownership stakes in an existing business or division, it creates a spinoff.
- When a parent company believes that a new division will be more valuable on its own than it was within the parent, it may decide to spin it off into its own company.
- A spinoff will have its own management structure and a new name, but it may continue to receive financial and technological support from the parent company.
- Shareholders’ money is usually well spent in a spinoff.
Understanding Spinoffs
A parent company will spin off a division if it believes doing so will increase profits. The spinoff will operate independently from the parent company and under a new name, but will use the same resources (including intellectual property and employees).
In most cases, the parent company will keep providing resources like money and new technologies.
What Goes Into Creating a Spinoff
When a company spins off an operating division, it gives all of its existing shareholders a stake in the new company.
Existing shareholders can be incentivized to swap their parent company stock for spinoff shares by receiving a discount.
If an investor had $100 in parent company stock, they would receive $110 in spinoff company stock. Because the newly separated businesses can put more resources toward developing their core competencies, spinoffs often result in higher financial returns for investors.
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Causes of Spinoffs
There can be many causes for a spinoff to emerge. But the overall belief is that it will be more profitable as an independent entity than it was as a part of the parent company. Additionally, the parent company may be in a stronger position to increase its value.
A spinoff can help a company better allocate resources to the areas of the business with the greatest long-term potential.
To save money and time, many large corporations spin off their least profitable or most unrelated subsidiaries. A corporation may, for instance, divest a mature division showing negligible growth in order to concentrate on a newer, more promising line of business.
Alternatively, a business unit may be spun off to create value on its own if it is moving in a different direction or has different strategic priorities than the parent company.
If a company tries to sell a division but gets no takers, it may decide to spin off that division. The move could increase the company’s worth to shareholders.
Risks of Spinoffs
The downside of spinoffs is that their share price can be more volatile and can tend to underperform in weak markets and outperform in strong markets.
The initial sales of spinoffs are sometimes very high. Some shareholders of the parent company might not want to invest in the spinoff they were given shares of.
Even if the spinoff’s long-term prospects are good, the share price may temporarily drop due to this selling activity.
Some Variations
The creation of spinoffs is fairly common. Dozens are typically made every year in the USA.
Some recent examples include the split of PayPal Inc. from eBay Inc. and the spinoff of Smith & Wesson Inc. from American Outdoor Brands Corp.
In addition, Jefferies Financial Group divested its Vitesse holdings and General Electric spun off its healthcare division, GE HealthCare Technologies, in early 2023.
In a Spinoff, What Happens?
When a parent company gives its shareholders a stake in a new division or subsidiary, that action establishes the new company as a legally distinct entity.
How Does a Spinoff Affect the Shares of the Parent Company?
Initially, a spinoff will cause the price of the parent company stock to drop as the assets now owned by the spinoff are removed from the parent company’s financials, lowering the company book value.
For shareholders of the parent company, the combined value of the two share prices should be close to the stock price of the parent company before the spinoff.
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Are Spinoffs Good for Investors?
They have the potential to be. After initial dips and volatility, company shares and spinoff shares typically outperform the market in the first two years after a spinoff.
The spinoff, despite its small size, benefits from dedicated and enthusiastic leadership and a promising business model. The increased interest from investors may lead to a higher share price.
Shares in a spinoff company are often risky because of its infancy and lack of a track record of financial success.
Conclusion
A spinoff, also called a spinout or starburst, is the formation of a new business entity from an existing one. It’s a form of divestiture that occurs when a parent company believes that a spin-off will be more valuable on its own and that the parent company can add value without being involved. The market’s reaction to a spinoff can cause significant share price fluctuations.
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