Laggard Companies Trying Spinoffs to Unleash Stock Value

Companies such as Hewlett-Packard that feel underappreciated by the stock market are increasingly turning to divisional spinoffs to create value, and the trend can be a boon for investors--if they choose carefully.

Long-term studies have shown that spinoff stocks “clobber” the overall market in their first years, according to one specialist who tracks this niche.

But more recent deals have included many disappointments, at least so far.

Data from Spin-Off Advisors in Chicago show that of 63 spinoffs that began trading between January 1996 and June 1998, only 29 had gained in price through Dec. 31 of last year. And only 19 beat the blue-chip Standard & Poor’s 500 index from their spinoff dates through Dec. 31.

But winners such as Lucent Technologies, up sevenfold since its 1996 spinoff from AT&T;, and Cognizant Technology Solutions, which has more than tripled since being spun off from IMS Health last June, show that business spinoffs can present lucrative opportunities.

Long-term, “these deals tend to be good for both the parent company and the new spinoff company,” said Joseph Cornell, president of Spin-Off Advisors. “For the parent, it’s a good way to shake up the business and concentrate on what you do best. And the managers of the new company are highly incentive-ized by stock options, and their egos are on the line.”

Hewlett-Packard, suffering from disappointing earnings growth in recent years, on Tuesday said it will spin off its medical-products and measuring-devices businesses to focus on its core computer businesses.

Cornell noted that a Penn State University study of 174 spinoffs from 1965 through 1994 found that the new firms’ stocks rose 76%, on average, in their first three years, outperforming the S&P;’s gain by about 31 percentage points.

The researchers found that parent companies also outperformed the broad market, though to a lesser degree. Studies by J.P. Morgan & Co. have found similar results.

Spinoffs have risen in number and dollar volume each of the last five years, Cornell said.

While every case is different, spinoffs come in two basic forms: “pure” spinoffs, in which a company breaks off a business in one shot, usually via new shares distributed to shareholders; and the increasingly popular two-step “carve-outs,” in which a company sells a 15% to 20% chunk of a division to the public through a stock offering, then distributes the remaining shares to its shareholders six to eight months later.

Cornell said pure spinoffs often stumble at first--which would explain the weak performance of many recent deals.

Shares of PepsiCo’s fast-food spinoff, Tricon Global Restaurants, for instance, fell about 10% in the firm’s first few months before management turned things around. The company was initially burdened by a heavy debt load, a price parent firms often levy in exchange for a spinoff’s freedom. But the Pizza Hut-KFC-Taco Bell chain quickly re-energized its business and the shares have zoomed 111% in the last year.

“Pure spinoffs often take six months or even two to three years to kick it into gear,” Cornell said. From Wall Street’s point of view, “they can fall through the cracks. It’s not like an initial public offering--they don’t have roadshows and analysts talking up the story.”

Indeed, the Penn State researchers found that spinoffs under-perform the overall market by about 1 percentage point, on average, in their first six months, before finding their footing.

For patient investors, that can spell opportunity. “Early on--that’s the time for bargain hunting,” Cornell said.

Carve-outs, meanwhile, tend to fare better off the bat because their parent has a vested interest in seeing the shares do well. “The big success stories like Lucent have really legitimized this technique in recent years,” Cornell said.

Last year’s equity carve-out volume of $11.5 billion in 14 deals shattered the previous record. In fact, the year’s three biggest initial public stock offerings by dollar volume were carve-outs: Conoco, from DuPont; Infinity, from CBS; and Fox, from News Corp.

Recent deals in the same mold include General Motors’ carve-out of Delphi Automotive, and now, Hewlett-Packard’s plan.

“Doing the IPO lets the parent company raise capital and get a bigger bang for the buck,” said Barbara Goodstein, spinoff analyst at Rothschild Inc. in New York. “And they can usually get a nice, high valuation” as analysts compare the new company with others in the same business, she said.

A recent Harvard University study found that a key to the success of many spinoffs is the additional coverage the new companies get from analysts attracted to the more focused business.

And the purest plays among spinoffs often become takeover bait, which Cornell said may be key to the stocks’ overall strong performance, despite many losers.

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Fending for Themselves

Business units spun off from their parent companies to fend for themselves can be big winners in the stock market, recent deals show. But the spinoff roster also includes many bombs. A sampling of spinoff deals since 1995:

Spinoff Winners . . .

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Stock gain Spinoff Date to date Lucent Tech. 04/04/96 +571% Earthgrains 03/26/96 +201 Dial 08/16/96 +123 Midas 01/30/98 +105 Tricon Global 10/07/97 +100

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. . . and Losers

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Stock loss Spinoff Date to date Octel 05/26/98 -40% Vlasic Foods 03/30/98 -54 Unisource 01/02/97 -59 Tupperware 05/31/96 -62 TCI Satellite 12/05/96 -94

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Source: Spin-Off Advisors