Spin-Offs: Investor Relations Takeaways & Tips
Corporate spin-offs are a regular if somewhat niche feature of the public company landscape in the U.S. They occur each year at approximately 1/10th that rate of IPO’s but track the same cyclicality, which in both cases appear to be coincident with GDP and the expansion and contraction (i.e. recessions) cycles across the economy. Plenty of ink has been spilled about the so-called death of IPO’s, which is admittedly a pretty dramatic overstatement when the statistical outlier years of the late 1990’s (dot-com bubble) is removed from such analysis. The rate of spin-offs taking place each year hasn’t changed materially either, but in this case, we believe there may be greater reason for expecting a break from the past, in this case toward more spin-offs. More specifically, with the rise Activists and Activist Funds as an asset class and the increasing participation of long-only “active” investors in this trend, partly in response to growing/shifting assets to passive vehicles, we thought it would be useful to put together for IRO’s a list of key action items related to being involved in an spin-off, as well as some historical perspective on performance and what to expect in terms of potential shifts in the shareholder base.
Spin-Off Stock Performance – Alpha IR’s Trading Analysis
Taking a look at stock performance for the Parent company and the SpinCo, we graphed the performance of both shares for the 12-month period after the effective spin date and connected this with the performance of the 12-month share price performance for the Parent company leading up to the effective date. As can be clearly seen, which is in-line with other historic share price performance we have reviewed for other measurement periods and spin-off groups, there is consistent tendency for the SpinCo shares to strongly outperform the Parent NewCo shares for several quarters following the spin.
- Analysis of the performance of SpinCo and Parent company shares points to an overhang experience by the Parent company that was not relieved by the spin-off transaction.
- The rally in SpinCo shares starts one-month following the effective date and exhibits an inverse, consistent pattern, from the Parent shares, even past the one-year post transaction. On average the SpinCo outperformed the S&P 500 by 19%.
- Dramatic underperformance was seen by the Parent following the effective date of the spin-off. Over the next twelve months on average shares were unable to recapture the lost ground and ended down over 10% when compared to the S&P 500.
1. Parent Co. IRO’s Undertaking Spin-Off Transaction – You Thought You Knew What Busy was?
From the perspective of an IRO, there are few events in a public company’s life, with the possible exception of an IPO, that will match the scale and duration of work involved in a spin-off transaction. The process of preparing for and completing a spin-off, once announced, typically takes close to one years’ time depending on the process chosen by the Parent Co. And while senior management will have the benefit of plenty of knowledgeable (and expensive), outside advisors to help direct this process, the typical IRO will basically see their work load more than double with most of that increase landing squarely in their lap.
The old adage that success is 90% perspiration most definitely applies here. In fact, because of the nature of what’s taking place and how the shareholder base for the SpinCo is created, we would say that the avoidance of failure in the form of a potentially orphaned stock and underperforming shares is the key focus for any IRO involved with a spin-off transaction. Therefore, having a specific game plan designed ahead of time is absolutely essential. Below we have put together a list of key items that IROs need to be prepared to tackle:
- To Own the Spin, Start with a Perception Study Whether the idea for the spin-off was home grown or foisted on the Company by external factors, management should fully embrace this step and treat it as their own. The announcement of a pending spin-off will shine a bright light on the motivations your holders. Chances are, the investment thesis of most of the top holders will be aligned, but some important differences likely exist and a spin-off announcement is likely to highlight these. A perception study at this stage is a “must have” in our opinion.
- For IRO’s, this is Essentially like an IPO: The current IR function for the pre-spin parent company will need to be re-created, at some proportion, in the spin-co. What form will this take? What resources will it have? Will the IR approach be the same, less or different? Historical information for the separated businesses needs to be prepared and presented in a manner as if being seen for the first time. Pro Forma segment data must be organized in a manner that is logically and historically consistent.
- Investor Communication Needs Throughout the Process Are Extensive – Prepare for Coming Volatility in Share Price and Shareholder Base: Volatility around spin/execution date is guaranteed. By understanding that some amount of shareholder churn is inevitable, you can position your early targeting work to position interested investors to take advantage of this volatility. Be prepared. The new shareholder base should stabilize within a 6-12-month time period, depending on the performance of the underlying businesses. To prepare for this inevitable turnover, it’s critical to meet with all top-25 holders over the course of pre-spin period. Understand and discuss criteria that would cause them to exit stock due portfolio rules and restrictions. As a famous investor has said regarding spin-offs, “…there’s a natural constituency of sellers and there’s not a natural constituency of buyers.”
- Who Will Own and Who Will Cover the New Companies? Target, Target, Target: Don’t forget that both companies, not just the spin-co, are newly minted public companies. While many existing shareholders may support this action, their post-split ownership decisions and actions can be modeled and discussed, but not guaranteed. Because the company is being split, the fit of one or both “new” companies within the guidelines of existing sell-side analyst coverage could be undermined. It should be assumed that one of the new companies will have to identify a new covering analyst and industry into which they fit. Because the sell-side business model is currently under siege with this structural change unlikely to change, nothing should be presumed.
- Target! Target! Target!: The upfront work on in-depth targeting analysis can prevent a lot of potential future headaches, as well as waisted time. Who should own each stand-alone companies’ shares and what kind of shareholder base would you like to achieve? One place to start here is to identify an appropriate peer group that each company should be measured against and compared to. With this as a starting point, a set of existing shareholders from this peer group can be assembled as an initial target group. From here, a more sophisticated and holistic approach can be completed.
2. Shifts in Shareholder Base – What to Expect
Legally, a spin-off is a dividend that is achieved through a pro rate distribution of shares in a subsidiary (“SpinCo”) to all Parent shareholders. This technically important point is useful to remember since the spinoff process itself “…is a fundamentally inefficient method of distributing stock to the wrong people”. The new owners of the firm (investors who received the spun-off shares), now own a firm that they never purchased. The spun-off firm may not meet their investment criteria. The parent may be a large-cap firm, while the spin-off a small- or mid-cap firm, or even micro-cap. As a result, once the spin-off’s shares are distributed to the parent company’s shareholders, they are typically sold immediately without regard to price or fundamental value. Indiscriminate index selling also contributes to initial downward pressure on spin-offs.
Alpha IR conducted a performance and shareholder base analysis of 30 spin-offs that were completed in 2015 or 2016. The study looked at the average of the 30 companies’ institutional investor base by style over a two-year time frame. The analysis began a quarter before the Parent entity announced its intention to spin-off a segment of its business all the way through a year after the close of the deal. Time frame for the SpinCo ran from a quarter post spin-off through a year post spin-off. Both the Parent and the SpinCo’s shareholder bases were analyzed to extrapolate the conclusions below.
A key takeaway from the study was companies, across the board, experienced a significant drop in Active ownership. Passive ownership grew 22.2% at the expense of Growth investors which fell by 21.4%. Value and Short-Term/ Hedge style investor ownership was reduced by 4.5% and 10.0%, respectively. Investors most likely in-tune to IR messaging decreased by 12.5% after the companies underwent a spinoff. As expected, the quarter after the spinoff transaction was complete the parent company saw a short spike in Short-Term/ Hedge ownership. (see second chart below)
Looking at the SpinCo ownership data 1Q post close as compared to the original parent company holding 1Q pre-spin announcement, we see a somewhat less pronounced but still meaningful 14.3% jump in passive holdings. The largest percentage change in holders in this case take place in the short-term/hedge category, which increased by an average of 70% over this time period. This is not a total surprise as the holding period for the SpinCo following the effective date exhibits consistent outperformance for the period and the group we studied, as well as all other spin-off company performance analysis that we have reviewed going back several decades. The largest drop for this comparison is also within the growth category of holders, but in this case the average decline was even more dramatic at close to 33%. Value and GARP holders each experienced a 1 basis point decline, on average, over the measured period in comparing parent company holders to SpinCo holders.
About Alpha IR Group:
Alpha IR Group is a full-service investor relations consulting firm that partners with companies to deliver best-in-class investor relations, from strategic insights to daily, tactical execution. Alpha IR offers a range of tailored programs, as well as sophisticated insights and significant experience with activist preparedness, investor day preparation and execution, earnings support, M&A/transaction support, perception studies, and more. The firm’s leaders have over 100 years of combined sell-side, buy-side, investment banking, and IR consulting experience. The firm has offices in Chicago, New York, and Boston. Alpha’s growing staff supports a client base that spans seven industry verticals and represents nearly $100 billion of equity value trading on public exchanges in North America.