The Case for Corporate Spin-Offs
By now, most people who are participating in the initial public offering market should have experienced their fair share of this IPO cycle.
The obvious difficulty with IPOs is that the owner of the business, in many cases, is trying to sell the business to yourself or other like-minded people. They are a seller and you are a buyer, and their intent is often to maximise the amount of money they receive from selling their business. This is done by portraying the business in a positive light and hiring sophisticated and experienced sales people to assist with the process.
Professional managers are often put in place to manage these businesses and rewarded according to how much the business is sold for. Large sums are spent promoting the sale through broker reports, newspaper articles, editorials and investment journals.
It is not always the case that owners are actually selling the business. They may simply be listing the business to raise new capital to expand or buy out a competitor. It is our experience that in these cases, floats generally do better because the owners have similar interests to the new investors – increasing the value of the business over time.
Since the GFC, the natural ebb and flow of the IPO market has been further skewed, in that just after the crisis IPOs were virtually impossible to close. The market was not open to buying new listings, or even exiting listed stocks for that matter. This was a particularly good time for private buyers, private equity and high-risk entrepreneurs to buy assets. With the GFC five years behind us, the window for IPOs is again well and truly open and there is a natural backlog of IPOs as well as a fresh batch astutely purchased privately post-GFC but now ready to be sold.
In our view, all this makes for a challenging IPO environment from an investor’s point of view, and tends to negatively skew the chance of making consistently good risk-adjusted returns. Added to this is the perennial problem that a company IPO is often the first time many investors have seen the business, so they have no history or previous accumulated investment knowledge on the stock.
We have found better success in the past 18 months investing in spin-offs. As the name suggests, it is a business or a group of related businesses that are spun off and listed separately on the stock exchange.
For example, Macquarie Group spun off Sydney Airports. Before that it owned the Sydney Airport assets within the Macquarie structure and as a shareholder you held your stake in Sydney Airports through Macquarie. When Sydney Airports was spun off, you owned a share in Macquarie as well as a new share in Sydney Airports, representing the Sydney Airport assets previously held inside Macquarie.
A company may spin off an asset that is considered non-core and does not fit into the portfolio of assets the company currently owns; or because the non-core assets are not getting the attention they require and management may not be prepared to commit the capital necessary to improve them.
Another reason may be that management may not believe it could access the capital necessary to improve these assets under the current structure.
Or the board and management may spin off assets from an existing ASX-listed company because they believe they may be more valuable separately listed. There may be competitors interested in acquiring the assets and having them separately listed facilitates a takeover. The separate listing serves as an excellent “price discovery process” to determine what the assets are actually worth.
Spin-offs usually well understood
In the instances mentioned, the assets being spun off are known to the listed marketplace and the investment community would have had a chance to analyse them within the original structure. In addition, the board and management are required to act in the interests of shareholders in recommending and implementing a spin-off. The entire process is highly visible and the outcome can be quite quickly seen as either having created value in the short run or not. This all adds to the impetus for spin-offs in general to be successful.
Taking this logic a step further, the board and management of the structure from which the entity is being spun off, spend considerable time ensuring the spin-off will be a success, because the ultimate shareholders of the spun off company are the same as those that remain in the original company. It is in the best interests of the board and management to make sure their existing shareholders are happy with a proposed transaction.
Spin-offs we have participated in this year are: Recall, spun out of Brambles; Orora, spun out of Amcor; and Sydney Airports, spun out of Macquarie Group. Recall is up approximately 21 per cent and Brambles around 4.5 per cent; Orora is up approximately 28 per cent and Amcor around 3.4 per cent; Sydney Airports is up approximately 17 per cent and Macquarie Group by around 12 per cent. These are good returns in an overall market that has not moved much.
We are confident you have not read nearly as much about spin-offs as you have about most recent IPOs. Similarly, we can be confident that a basket of IPOs did not do as well as a basket of spin-offs, and this would almost certainly be the case on a risk-adjusted basis.
Perhaps most importantly for most investors, buying shares in these companies before the spin-off was as simple as leaving an order to buy stock. No tense bidding process, scalebacks or unhappy discussions about poor allocations in successful floats and fantastic allocations in poor floats. As usual with investing, returns appear where most people are least expecting them.
As a final note, we are currently looking at Orica, which has announced a spin-off. Orica is a 1 per cent position in the Cadence Capital Limited Fund.
Written by Karl Siegling, August 2014