The first topic in the book is Spin-offs. When a company decides to ‘spin-off’ a subsidiary or business, it may issue shares of the division being spun off to the existing shareholders. This spin-off may be 100% where in the parent company distributes its entire holding of the spun-off division to the exisiting shareholders based on the valuation of the division.

For ex: when reliance was split into the petrochemical, communication and other businesses, the shareholder were given shares in the spun off divisions based on the valuation of each business.

Spin-offs may partial where the parent wants the market to realize the value of the division and so by doing a partial spin off, the newly spun off company is now valued by the market independently. This enables the company to demonstrate the hidden value of its subsidiary and get a better valuation for the whole company.

In addition there are a few additional reason for spin-offs

a. The company wishes to spin-off a poorly performing division and improve the valuation of the parent company
b. In a regulated industry, by spinning off the regulated division, the parent can operate in a non regulated environment c. The company wishes to improve the valuation of the company by making the subsidiary an independent company with its own management and policies. This improves the valuation of the parent and the spun off company as both can now focus on their core businesses.

The reasons why spin-offs create an opportunity for the investor are listed below

a. The spun off division may be very small with a low market cap. As a result large instutional investors may not be interested in holding it due to various constraints. This creates a selling pressure and drives down the price.
b. The spun off division with its independent management can now focus on the business better and hence perform better in the future
c. The market may give a better valuation to the spunoff business depending on the nature of the industry in which it operates

update : 03/29

An additional approach to profit from spin offs is to look for situations where the company plans to conduct a rights issue instead of an outright spin-off of the subsidiary. In such cases the company is planning to ‘sell’ the division to its shareholders via a rights issue and raise some capital at the same time.

This modified and rare type of spinoff approach is profitable for the same reason as the usual spin off. In such cases large institutional investors may not subscribe to the offer due to illiquidity of the new issue. In addition if the spin off via rights is beneficial to the insiders , then it would make a lot of sense to subscribe to this spin off via rights purchased from the market or via direct purchase of the parent company’s stock.

An additional point repeated by the author several times in this section is that an investor should analyse closely the actions and motivations of the insiders during the spin off. Does the spin-off benefit the insiders ? do they have a stake on the upside ? Answers to these questions would help an investor make a good decision

7 Comments

  1. koty says:

    Hi! Rohit,
    Have you studied Kohinoor Foods Ltd. I think it is a value play especially now that it has foreyed into ready to eat food market. It has a strong tie up with the foreign retailers and a reasonable valuation. Also as the Basmati production was affected in Nov and Dec the demand is likely to be high.
    KFL’s stateof-
    art rice milling plant is located in Murthal, Haryana with capacity of 40 MTPH (Metric Tones Per Hour). The company has
    strong network of Artiyas to facilitate smooth paddy procurement.
    KFL has forayed into Ready To Eat market with its facility at Bahalgarh, Haryana. Its ambient food capacity stands at
    50,000 pouches per day and frozen food capacity stands at 20 metric tons per day. Frozen foods capacity is recently commissioned
    in FY07.
    The major players providing Indian RTE food are KFL, ITC, MTR & Tasty Bites. Amongst them ITC, MTR & Tasty Bites focus on
    domestic markets, while KFL focuses on international markets deriving more than 90% of its RTE sales from exports. The
    demand for Indian RTE is on the rise on back of increasing entice for Indian cuisines. Competition in the international RTE food
    market is expected to remain low owing to its mammoth size, which is still expanding.
    KFL has emerged has a major player in the branded rice market in global arena. This is clearly evident from the fact that the
    branded basmati rice segment has grown from 34% to 51% of the total revenues in FY06.

    Can you offer some comments on this??

  2. RaviAranke says:

    Great Eastern shipping went through a spin off (separated Great offshore) few months ago.

    I analysed the situation in light of Greenblatt’s comment to track insiders. My comments are on my blog flatworldvalueinvesting.

    Cheers,
    Ravi

  3. Rohit Chauhan says:

    Hi koty
    i have never looked at the RTE business till date. will have a look at let you know

    ravi – have you analysed how the spin-off has performed ?

  4. RaviAranke says:

    Rohit,

    ravi – have you analysed how the spin-off has performed ?

    It could take a year or even 2 years (Greenblatt mentions that outperformance is better in 2nd year).

    So far, both the GEs – shipping and offshore – have underperformed since they were separated in Dec 06. This is expected as people dump the shares they don’t want – in this case, Great offshore. I am going to study Great offshore as possible investment.

    Greenblatt mentions parent company (in this GE shipping) might also be interesting – especially if the insiders are aligned with you. The ducks seem to be aligned for GE shipping as well going by insider purchases.

    All in all, I believe this is a classic Greenblatt textbook case. It would be interesting to see how it evolves over next 12-18 months.

    Any other mergers/spin-offs that you are watching?

    Regards,
    Ravi

  5. Anonymous says:

    Hi Rohit,

    I am Saurabh, I blog @ http://pseudosocial.blogspot.com and wanted to send a mail to you. Could not find your email address ..

    Can you please send it .. (my email address is pseudosocial@gmail)

    Thanks

  6. Ranjit kumar says:

    Hi Rohit,

    Today RBI has increased repo & CRR again. Please can you give me your historical perspective on these high interest rates and also what would you do in such situations, would you move into FD’s for some time or would you stay invested fully.

  7. Rohit Chauhan says:

    hi ranjit

    my personal experience with interest rates has been from 95 onwards when i saw the rates move to 15% and since then it has been a downwards movement.

    my stock market positions are not based entirely on interest rates (at least not in the past). if i find a compelling buy, i go ahead with it if the expected returns are good.

    since 2003 i have moved into floating rate funds and plan to continue . floating rate funds are more tax efficient than FD’s and far more liquid , although absolute returns are less

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