Spinning Off Diamonds in the Rough or Just Selling Trash? – EP6

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Remember those funky Snapchat Spectacles? People waited hours in line in New York when they came out. They sell on Amazon for a hundred and thirty bucks.

Twelve months later the company wrote down forty million dollars because of unsold Spectacles. The stock tanked.

Hi! I am Doctor Scott Brown and I am here to show you what works in the investment markets. I also show you what does not work and how to avoid it.

Do managers of large corporations habitually overinvest in lower value pet projects? This is an important question.

If they do invest in crappy stuff it destroys the value of stock investment. For this reason, some academics argue that dividends should be forced to pay or increased.

But following such a hard stance requires conclusive proof of widespread bad corporate management. Is management that bad in corporations today? We can learn a lot from corporate actions.

In the typical top management hijacked firm of today a corporate action must be approved by both the directors and the CEO as president of board. What are corporate actions? These directly impact ownership structure.

Acquisitions and mergers are well known in the public. Ditto for takeovers.

As such corporate actions are events that tend to jostle the common stock price.

The most common is a cash dividend payment.

Also common are share repurchases. Some firms offer direct shareholders a dividend reinvestment plan.

Less common events are rights issues.

Some corporate actions dilute the ownership of existing owners because new capital is not raised from the public. Stock dividends, stock splits, and bonus issues are described by professor Crack as votes of confidence. Reverse splits are not.

Make sure you get his essential pocket guide to finance How to Ace Your Business Finance Class on Amazon today.

Least understood among investors are a rare class of liquidations that involve selloffs, spin-offs, and carve-outs.

Professor Crack has a PhD from MIT Sloan. My mentor Eric Powers holds the same degree.

Eric published the most important study to date on how liquidations impact common stock prices in his Journal of Finance publication entitled Learning about Internal Capital Markets from Corporate Spin-offs coauthored with MIT Sloan finance professors Robert Gertner and David Scharfstein.

A corporate spin-off creates an independent new company that is not under the control of parent management. So, does a sell off. What is the difference? The sell off generates cash for the conglomerate the spin off does not.

The announcement of a spinoff, selloff or carveout increases the share price of the parent. New firms that have been spun off from large conglomerates tend to increase in profitability and share price. This is particularly so for cross industries. Companies that have been carved out decline in profits and share price.

A follow up study in the Journal of Financial Research by professor Powers shows companies with weak operations opt to sell off or carveout a division. The carveout operates in an industry with more investment opportunities and employs higher value assets than the spin off.

Carveout firms also tend to work in industries closely related to the parent. But operational performance has likely peaked.

The takeaway is that conglomerates partially divest hot divisions with carveouts during strong bull markets. Management uses a selloff to take out the trash.

Spin offs are the result of cash strapped firms seeking liquidity.

Thus, it is no surprise that the announcement of a spin off has the strongest affect in buoying the parent company stock price. And these are more likely to show operational improvements.

An example is the Ferrari divestiture from conglomerate Fiat Chrysler.

Fiat Chrysler raised cash through an IPO of ten percent of the shares in Ferrari. These went to new shareholders. Eighty percent of shares spun to old Fiat Chrysler shareholders. The final ten percent is held by Ferrari Vice Chairman, Piero Ferrari son of founder Enzo.

Look at the one-year daily price charts of Fiat Chrysler, symbol F-C-A-U and Ferrari, symbol R-A-C-E. Notice that both firms have a similar price pattern. You would have done well investing in either the parent conglomerate or carveout.

Finally notice that Fiat Chrysler no longer owns shares of the firm but did raise cash through the small fraction in the IPO. Hence this deal has aspects of both a spin off and a carve out.
What’s the takeaway?

Just remember in general that carveouts are the best assets on the chopping block but say no to down trending operational profits. And you will often find yourself looking at two firms in the same industry after a selloff.

Spinoffs are a mixed bag. But the divestiture produces to unrelated firms in different industries. This can ease analysis if it is obvious which industry is stronger.
And selloffs are trash.

If you want more information like this go to Rhodes Society dot Org right now.

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