Spinoff Investing: How to Profit from Wall Street’s “Trash”
Spinoff Investing: How to Profit from Wall Street’s “Trash”
EXECUTIVE SUMMARY
- The Mechanism: When a giant conglomerate (Parent) spins off a small subsidiary (Child) into a separate public company, they distribute shares of the Child to the Parent’s shareholders.
- The Opportunity: Institutional investors (Index Funds, Mutual Funds) often must sell the Child shares immediately because the company is too small, doesn’t pay a dividend, or isn’t in the S&P 500. This “Forced Selling” depresses the price artificially.
- The Strategy: Buy the Child stock after the spinoff is complete (usually 1-2 months later), when the selling pressure subsides but the underlying value remains high.
- Anti-Exaggeration: Not all spinoffs are gems. Sometimes companies spin off debt-laden “bad businesses” just to get rid of them. You must check the balance sheet.
Why did PayPal stock explode after it was spun off from eBay? Because eBay shareholders wanted an e-commerce stock, not a payments stock. They sold PayPal indiscriminately, crashing the price. Smart investors bought the dip. Spinoff Investing is the art of buying what institutions are forced to sell. It is a structural inefficiency in the market that has persisted for decades. According to Team BMT Analysis, this is the most reliable “Event-Driven” strategy for individual investors. Source: Deloitte Spinoff Research / The Edge Group
Scenario: MegaCorp ($100B Market Cap) spins off MiniCo ($1B Market Cap).
- The Institutional Problem: An S&P 500 Index Fund owns MegaCorp. It receives shares of MiniCo.
Rule: The fund cannot hold MiniCo because MiniCo is not in the S&P 500.
Action: The fund sells MiniCo immediately, regardless of price/value. - The Price Dislocation: MiniCo trades at 5x Earnings due to the selling pressure.
Real Value: Similar peers trade at 15x Earnings. - The Result: Once the selling stops (approx. 30-60 days), the price rebounds to fair value (300% gain).
Performance: Spinoff Index vs. S&P 500
| Asset Class | Annualized Return (20-Year Avg) |
|---|---|
| S&P 500 | 10 |
| Bloomberg US Spinoff Index | 14 |
*Chart Note: Spinoffs consistently outperform the parent company and the broader market because management is finally incentivized (via stock options) to grow the smaller business.
CRITICAL SCENARIO: The “Toxic Waste” Filter
Is it a treasure or a trash can?
| Indicator | Verdict |
|---|---|
| Parent dumps huge debt on Child | Avoid. The spinoff is being set up to fail (bankruptcy risk). |
| Insider Buying (CEO buys shares) | Buy. Management knows the real value and is putting their own money in. |
Execution Protocol
Use sites like StockSpinoffs.com or SEC filings (Form 10-12B) to track upcoming separations.
Decision Order: Identify Spinoff โ Check Debt Load โ Wait for Institutional Selling to Subside.
Buy the parent company before the spinoff if you want to receive the shares tax-free. OR (Better): Wait and buy the child company in the open market after the crash. The latter usually offers higher alpha.
The Invesco S&P Spin-Off ETF (CSD) exists, but it often buys too early or holds too long. Spinoff investing is best done as a “Sniper” (picking individual winners) rather than a “Shotgun” (buying all).
WEALTH STRATEGY DIRECTIVE
- Do This: Look for “Orphaned” securities. If a company is spun off and no analysts cover it, that is the sweet spot. Information asymmetry works in your favor.
- Avoid This: Buying a spinoff just because it’s famous. GE spinning off its healthcare division is well-known and efficiently priced. You want the obscure, small, and unloved ones.
Frequently Asked Questions
Why do companies spin off?
To unlock value. “Sum of the parts is greater than the whole.” A conglomerate trades at a discount. Breaking it up allows each part to trade at its proper multiple.
Is it tax-free?
Usually, yes. The distribution of shares to the parent’s shareholders is a tax-free event (Section 355). However, selling them later triggers capital gains tax.
What is Joel Greenblatt’s advice?
He says to look for “incentives.” If the new CEO of the spinoff gets a massive stock option package priced at the spinoff lows, bet on that CEO making the stock go up.