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How to Profit From Stock Spin-Offs

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By David Sterman

NEW YORK ( StreetAuthority) -- When Forest Oil (FST) announced in late 2010 that it would spin off its Canadian energy fields in a new company called Lone Pine Resources (LPR), investors shrugged.

But investors who bought the parent of the spin-off when the deal was completed on Oct. 3, 2011, are glad to have waited. Since then, shares of Forest Oil have moved up from $9 to a recent $14. (Shares dropped from $15 to $9 in early October when the spin-off took effect, pushing shares up to an equivalent of $20 when the value of the spin-off is included).

The key catalyst: Forest's remaining business has become much easier for investors to assess.

Perhaps the main takeaway is that you should hold off buying a company when it announces a plan to spin off a division. Instead, you should pounce when the deal is done. Not only has Forest Oil rebounded more than 50% after the event took place, but Lone Pine Resources is up more than 20% since early October as well.

Just one day after that deal was done, on Oct. 4, 2011, Fortune Brands (FO), a diversified conglomerate, cleaned up its act by spinning out its liquor business, now known as Beam (BEAM). The remaining business, known as Fortune Brands Home & Security (FBHS), became more of a pure play on the company's security and home construction businesses. Since then, shares of Fortune Brands are up 57%, while Beam is up 26%.

Look for more of these spin-offs to come.

Investment bankers, hurting for fresh ideas these days, are likely knocking on the door of any major corporation that will listen to their sales pitch. Breaking up into two or more pieces can be profitable for shareholders if the company is suffering from a "conglomerate discount." This term refers to a company's relatively low valuation because investors have a hard time assigning a price-to-earnings (P/E) multiple on a group of different businesses with varying growth rates.

As an example, recent media reports suggested that Cisco Systems (CSCO) wanted to unload its cable-TV set-top box business, because the unit carried lower margins and smaller growth rates than Cisco's other businesses. In theory, Cisco would garner a higher P/E ratio if it was a faster-growing company with a higher margin profile. Cisco has since refuted the chatter, so this may be an event that takes place down the road -- if at all.
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