Spun-off companies tend to perform better than the broader market and often better than their former parent. For investors, the appeal of spin-offs lies in their long history of outperforming the broader market, particularly in the years immediately following separation from a corporate parent. A spin-off occurs when a parent firm distributes shares of a subsidiary to the parent’s shareholders (often tax-free).
Numerous studies have demonstrated that spin-offs outperform the overall market by a large margin. Spin-offs, as a group, tend to outperform the broader stock market. During the past 15 years, (through 2017) the Bloomberg U.S. Spin-Off Index returned 999.4%, while the S&P 500 Index returned 203.9%.
Many diversified companies are electing to spin off parts of their business finding that this restructuring technique can create significant value for shareholders. There were 19 spin-offs in 2017 that were worth about $76 billion in initial market value; “2017 Spin-off skinny,” lists them based on returns. The Bloomberg U.S. Spin-Off Index produced a total return of 35% in 2017, versus 21.8% for the S&P 500.
The rational for spin-offs varies. Some companies wish to get rid of a weak or low-margin division that is detracting attention from the parent. Other companies seek to highlight the attributes of a desirable unit whose full value may not be reflected in the parent’s stock price. Whatever the underlying motivation for spin, they tend to do well for investors.
Why do spin-offs prosper? Much of the impressive performance comes from the altered dynamics of the spun-off business and its parent. Spins do well partly because there tends to be pent-up entrepreneurial forces unleashed when a business and its management are freed from a large corporate entity. The combination of accountability, responsibility and more direct incentives take their natural course.
Managers have greater freedom to pursue new ventures, streamline production and pare overhead. After the spin-off, stock options can more directly compensate management of the new company. This often leads to improved operating performance over time. When one reconstitutes the parent and spin-off after a one- to two-year period, often outstanding overall returns are observed.