Over the years we have found the vast majority of our investment opportunities by focusing on stocks that have significantly underperformed. However, every so often we go slightly off-piste and come across other unloved candidates. For example, we often explore companies that have been spun off from much larger parents. Unsurprisingly as the world’s largest market – and one not short of activist investors – the majority of spin-offs are found in the US. However, a healthy number pop up in other markets. Just looking at the FTSE 350 Index one can find, among others, Howdens Joinery (born out of MFI), Aggreko (from Christian Salvesen), Astra Zeneca (from ICI), Britvic (from multiple ownership), Direct Line (which was an IPO but came out of RBS), Indivior (from Reckitt Benckiser) and Mitchells & Butlers (from Six Continents).
My colleague Guillaume Redgewell who works on our Global Value strategy has written on this subject previously (please ask your Investec Asset Management contact if you would like a copy of his note) and reached some firm conclusions.
In summary, investing in spin-offs has proved highly profitable. Why? Guillaume highlights a number of reasons. Firstly, an investor typically receives a reasonably small holding following a spin-off. For example, if a stock represents 1% of an investor’s portfolio the spin-off may represent as little as 10 or 20 basis points and therefore most likely to be viewed as a scrap to be sold. In some cases, for example, if held by an index fund, this scrap may be sold automatically. Interestingly these actions seem to be discounted in the first day’s price as there is no evidence that waiting for any stock overhang to be sold aids investment performance.
Of much greater long-term relevance than this technical issue is the opportunity for spin-offs to perform better as independent units. Perhaps the management was starved of cash (for organic and inorganic growth), not permitted to sell non-core time-consuming assets or not optimally incentivised. Even if there are investor roadshows to highlight the spin-off, investors might be sceptical (given there is often a lack of an impressive track record) or if the spin-off is not looking to raise fresh money, management have no great incentive to talk the story up.
Obviously, not all spin-offs work well for investors. They can start life with too much debt, poorly incentivised management, or too high a valuation. But, in general, they have performed better than the market and continue to throw up some interesting opportunities.