Better Call Saul, The Colbert Report, Law & Order: SVU — Sometimes a spinoff is just as good as the original.
Wall Street has seemingly taken that lesson to heart. Corporate spinoff activity surged by 33% in 2022 to its second-highest level on record, according to a new analysis by Goldman Sachs.
A spinoff occurs when a company splits off a portion of its business into a separate company. The parent company may distribute the new company's stock to its shareholders, allowing them to own shares of both.
The new company created through the spinoff operates as a separate entity with its own management team and board of directors, and typically has a different focus or strategy from the parent company.
In a year with a notable lack of merger activity and initial public offerings, US companies announced 44 new spinoffs and completed 20 of them, worth a total of $61 billion.
Expect the bonanza to continue this year, say Goldman analysts. The economic climate that supported spinoff activity last year remains in place: Rising interest rates, peaking profit margins, and below-trend economic growth.
What's happening: Spinoffs can be all round, as the spinoff allows the parent to focus on its core operations, while the new company can operate with greater flexibility and focus on its specific business areas.
These so-called SpinCos typically outperform their parents, can drive growth and offer a boost to shareholders during bad years for the stock market. That could explain why even some well-established companies initiated spinoffs last year.
General Electric completed its spinoff of GE HealthCare ($26 billion) followed by Intel's Mobileye ($22 billion). Johnson & Johnson, Kellogg and 3M are expected to create new SpinCos this year.
Trouble in paradise: Spinoffs offer investors the potential for greater flexibility, simplified business models, and focused management teams. Wall Street tends to like that.
Of the 377 spinoff transactions completed since 1999, shares of SpinCos beat those of their parents by a median of 4 percentage points after their first year, and by 7 percentage points over two years, according to Goldman Sachs.
But in the 2022 cycle, while 11 of the 20 spinoffs outperformed the S&P 500 since transaction completion, only six outperformed their parent entities.
So what's going on? Blame lower profit margins, says Goldman. These smaller, newly formed companies are still in the process of establishing themselves in the market and often have lower profit margins than their parent company. Typically, that's an acceptable tradeoff by investors if the company has strong long-term growth potential.
But not in this environment. It costs a lot to borrow these days and investors are looking for high profits and value stocks, writes Goldman.
So will this year's SpinCos be more of a Joanie Loves Chachi than a Frasier? It all depends on how much profit they can deliver.
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