Aluminum maker Alcoa (AA) became the latest to announce plans to split into two separate companies on Monday. But experts caution the spinoff arena is getting crowded so investors need to scrutinize each plan carefully for debt levels, pricing, sector market performance and other factors before jumping in.
"We see more and more spinoffs coming to market," said Jonathan Morgan, a deals analyst at Edge Consulting Group, an equity research firm that specializes in spinoffs. "There's been a lot of winners in the last two or three years, but in this market we're seeing a lot more losers coming out."
The number of spinoffs in the U.S. rose to 44 in 2014 from 13 in 2010, according to Dealogic. So far in 2015, 25 have been completed and many others announced.
Activist investors including Carl Icahn and Nelson Peltz have been driving much of the spinoff trend, launching proxy fights and arm-twisting management to spin off businesses into separately traded companies. Basically, they're making a bet that smaller, more nimble companies with a sharp focus on a single business area will be rewarded with a higher stock price than a business that's buried in a larger conglomerate.
In many cases, they've been right.
A study conducted by Edge Consulting and Deloitte found that six out of every 10 spinoffs of companies with market caps of at least $250 million generated positive returns the first year; 40% of all spinoffs over the past 15 years clocked returns of more than 20% the first year and 48% the second year, said Morgan.
"The name of the game today is return on equity, especially in this low-yield environment," said Robert Profusek, head of mergers and acquisitions at Jones Day. "If one of a company's businesses is sucking capital and the other doesn't need it, does it make sense for them to be under the same roof?"
In July, there were a flurry of spinoffs, including Baxter International's (BAX) spinoff of its biopharmaceutical unit, Baxalta (BXLT) , DuPont's (DD) spinoff of its performance chemicals segment, Chemours (CC) , NiSource's (NI) spinoff of its Columbia Pipeline Group (CPGX) and eBay's (EBAY) spinoff of its digital payments business, PayPal (PYPL) .
Many more are pending: Hewlett-Packard (HPQ) unveiled plans to split into two listed companies, which will effectively separate its computer and printer businesses from its faster-growing corporate hardware and services operations and Darden Restaurants (DRI) plans to spin off some of its properties into a real estate investment trust.
In addition, Ashland (ASH) plans to split into two public companies, one focusing on specialty chemicals and the other lubricants; Industrial conglomerate Danaher (DHR) unveiled plans to split itself into two publicly traded entities next year. Then there's Alcoa, which is splitting its smelting and downstream businesses into two separately traded entities in a tax-free spinoff.
In the case of HP's planned spinoff, the jury is out. HP has been grappling with declining personal computer revenue, management changes and corporate scandals for much of the past decade. It explored several options, including merger talks with EMC (EMC) last year before pulling the trigger on the spinoff strategy.
The company had been considering a spinoff as far back as 2011 but Chief Executive Meg Whitman shelved the idea, saying the company was better off as a single entity than split apart. When Whitman changed her mind earlier this year, analysts became cynical. Many felt the spinoff decision was fueled by weakness and desperation, not strength.
"I think there's always value in splitting a company up," said Morgan. He noted two out of every 10 spinoffs are taken out by a larger entity within two years, and this could be HP's best hope for big returns.
Investors would love to see a repeat of the Motorola (MSI) spinoff of 2011, when its newly spunoff Motorola Mobility unit wound up being acquired by Google (GOOGL) that same year for $12.5 billion. "It became very successful from a sale perspective in terms of unlocking value," said Thomas Ivey, a partner at Skadden, Arps, Slate, Meagher & Flom LLP. Google sold the company to Lenovo (LNVGY) last year.
Analysts are bullish on the Darden spinoff. Darden, which owns the Olive Garden and Longhorn Steakhouse restaurants, plans to transfer about 430 of its restaurants into a publicly traded real estate investment trust and then lease the properties back. The spinoff is aimed at unlocking value from its real estate assets. For Profusek, it's a no-brainer. "In the restaurant business, why own the real estate? Let a real estate guy own that," he said. And with real estate prices currently at lofty valuations, the potential returns from the REIT could be high.
Analysts are cautious on Ashland's plan to spin off its engine lubricants unit into a publicly traded company, Valvoline for timing reasons. While analysts applaud the plan, the market hasn't been kind to companies in the chemicals and commodities sectors. Just ask DuPont -- Chemours' stock is down 70%. "It had a lot of debt on its balance sheet, and a lot of the commodity stocks are getting killed in the market," said Morgan.
"You don't want to do [a spinoff] if a sector is in the crapper," added Profusek.
Pricing is another issue. If there's tremendous hype around a particular spinoff, such as PayPal last month, it can cause the company's value in the "when issued" market to spike, leading to a high spinoff price. "It was just trading way too high for our valuation," said Morgan, who recommended his clients short the stock. Since the spinoff in July, PayPal's shares have sunk 24%.
Morgan believes the spinoff trend is nearing a peak. "We believe there will be a market correction in the next 12 months with regards to spins," he said. "We're advising clients and investors to be cautious and not get caught up in the bubble."