We could call 2014 "the year of the spinoff" – except that early returns suggest that 2015 may claim the title instead.
This year, there will be 58 spinoffs in the United States, where a publicly traded company splits up and spins off one or more subsidiaries, according to Spin-Off Research, a Chicago firm dedicated to analyzing this niche group of stocks. That's the most since 2000, the firm says.
But since spinoffs take some time to execute, the announcements of future splits give us some insight into what 2015 will look like – and right now, the numbers are tracking ahead of the similar period this year. Prominent names planning or exploring spinoffs include eBay Inc., which said it will spin off its fast-growing PayPal business, and Hewlett-Packard, which plans a division into consumer and "enterprise" businesses.
The trend is muted, although not absent, in Canada: After a year of retailers spinning off their stores into real estate investment trusts in 2013, the big initial public offering of 2014 was Prairie Sky Royalty, which emerged from the assets of Encana Corp.
The rush to break up sounds like a corporate-management fad or a scheme to enrich investment bankers with an endless series of transactions. But investors can actually see their portfolios grow bigger as these companies get smaller. And the profits may come at a surprising time.
Typically, stocks pop at the promise of a spinoff, either when an activist investor with an eye for a breakup takes a position, or when a company announces its own strategic review.
But that quick gain "often dissipates as people realize the spinoff is far in the future, if it's going to happen at all, so it begins trading on its own merits," says Joe Cornell, CEO of Spin-Off Research. It's actually six months after the transaction is complete, to two to three years after, "where the big bang for the buck is."
Academic research has supported that thesis. And so has the performance of the Guggenheim Spin-Off exchange-traded fund (NYSE Arca ticker: CSD), which has outperformed the S&P 500 by nearly five percentage points over a three-year period and 4.5 percentage points over a five-year period. It's rated five stars by Morningstar.
The Guggenheim ETF tracks a spinoff index it licenses from Beacon Trust Co. The Beacon Spin-Off Index rebalances twice a year, adding spinoffs that have been trading for at least six months and removing those that have been on the exchanges for 30 months. (That captures two years of spinoff performance, starting at the six-month mark.)
Why the delay? Guggenheim's William Belden, the manager of the ETF, notes that some institutional investors that hold the parent company as part of their strategy may not find the spun-off subsidiary as suitable. "If you were an S&P 500 index follower, and a transaction gave you a spinoff in your portfolio that isn't aligned with the strategy, you'd be selling those off because they don't fit with your criteria." The selling from those types of owners put downward pressure on the shares for some time after the spinoff.
"Another reason is best characterized as the dust settling from the transaction and whether the team put in place to deliver performance at the spinoff needs to get their bearings before executing on their strategy," he says. Companies often cite a desire for "increased management focus" on the spun-off company; Mr. Belden's comments suggest there's something to that.
The top holdings in the fund as of Thursday were Kraft Foods Group Inc.; Navient Corp., a loan-servicing business split from U.S. lender Sallie Mae Corp.; CST Brands Inc., a convenience-store operator spun off from Valero Corp.; WhiteWave Foods, an organic-foods company that was once part of Dean Foods; Mallinckrodt PLC, a pharmaceutical company spun off from Covidien PLC; and Allegion PLC, a security business split from Ingersoll Rand Corp. Navient was one of 14 stocks added to the ETF this month in its semi-annual rebalancing. (See chart for complete list).
Mr. Cornell's Spin-Off Research tracks the transactions globally and makes recommendations to its clients. Two of the firm's top picks are in the REIT sector.
New Senior Investment Group Inc. is a REIT that owns 91 senior housing properties, primarily independent-living facilities with less health-care exposure, across 27 states. It spun off from another REIT, Newcastle Investment Corp., in November. Spin-Off Research uses trading values for peers in the REIT business to figure New Senior's fair value at $25 a share, 46 per cent upside from Friday's close of $17.16.
CareTrust REIT, with 97 properties ranging from assisted-living to hospice care, was spun off from Ensign Group in June. Spin-Off Research figures CareTrust's fair value at $20, 75 per cent upside from Friday's close of $11.45.
Other spinoffs with 20-per-cent upside or more from the firm's action list include Abengoa Yield PLC, a British power company; Alliant Techsystems Inc., a defense contractor and gun maker; and Halyard Health Inc., a medical-device company spun off from Kimberly-Clark Inc. in October.
As for Canada? Well, for now, the strategy is a bit harder to engage in, because most of the TSX's spinoffs didn't fly under the radar.
Retail investors hungry for yield eagerly anticipated the REITs spun from Loblaw Cos. Ltd. and Canadian Tire (Choice Properties REIT and CT Real Estate Investment Trust, respectively). The demand for those names largely offset any selling pressures from the new owners, and the shares have generally been on an upward climb since their 2013 debut.
PrairieSky Royalty Ltd. is trading below the highs set this summer, when it was freshly spun from Encana. But that says more about the recent woes in the energy patch than it does about any spinoff-related opportunity.
If Canadian concerns catch the spinoff fever exhibited by their southern brethren, we know now when that investing sweet spot may occur.
The Guggenheim Spin-Off ETF
The Guggenheim Spin-Off ETF tracks the Beacon Spin-Off Index, which adds stocks at least six months after the company has been spun off and holds them for up to two years from the spin-off date. These 14 companies were added to the index on Dec. 12: