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Equity Instruments
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Common Stock
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Preferred Stock
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Tracking Stock
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Spin-off
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Partial Spin-off
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Stock Rights
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Stock Classes
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Real Estate Investment Trust
(REIT)
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Spin-Off
Spin-offs involve distributing to shareholders
a subsidiary or division, which usually does not have synergies with the
core parent company. Normally, these are non-core and/or under-performing
business units. It’s an easy way for a company to reduce cost and eliminate
low profit margin segments, thus improving the consolidated margins on the
remaining businesses. Additionally, shedding weaker divisions refocuses
management’s attention on its main business. The resulting higher margin
business may make favorable impressions on the stock analysts and investment
bankers, resulting in higher valuations for the parent company.
The newly created spin-off may also benefit by not
being constrained by the bureaucracy of a larger parent company, and might
become more entrepreneurial and profitable. When the shares are initially
distributed as a new public company, however, these issues may not meet the
portfolio criteria of many investors, and may be sold, sometimes regardless
of price. One may also wind up with only a small number of shares, and the
securities might become more of a nuisance to hold, rather than a valuable
asset. Additionally, since stock analysts can only cover a dozen or so
stocks at one time, these companies may be left with no coverage. This
culmination of events leads to initial selling pressure on the stock. The
investment strategy should be to wait until the selling subsides and the
price stabilizes at its fair value, before making a decision. Additionally,
be aware of instances where management loads up the spin-off with debt,
making it difficult for the new company to make a fair return going forward
for its new investors.
There are also a few situations where a company’s mix
of businesses is confusing to the investment community, resulting in a total
market value that is lower than the sum of the individual businesses. This
is the same issue as the drawbacks of the conglomerates in the 1960’s.
Normally, in these situations, the parent company can either have a full or
partial distribution of certain divisions or subsidiaries.
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