“Sometimes when you mix a fabulous business with a more mundane one, the market values it as a more mundane business. And literally just separating the two enables the market to understand the values.” - Bill Ackman

Many activist shareholders push for spin-offs as a means to unlock shareholder value. These situations typically arise when the activist investor believes that one of a company’s business segment could achieve a higher valuation as an independent company. The primary targets of such actions are usually conglomorates who own high-performing business segements that share no synergies with the rest of the company. For example, maybe a software company wholly owns a data management company - while the two are related, they may not share enough synergies to justify ownership.

Activist shareholders like spin-offs because they offer a wide variety of benefits to everyone involved:

• Appropriate Valuation - The spin-off enables the business segment to achieve an appropriate valuation, which could be many times higher than their valuation operating under the parent company.
• Generate Cash - The spin-off provides an opportunity for the parent company to generate significant cash on the sale and even unload some of its debt on the new entity.
• Tax Free Distribution - The spin-off enables parent company shareholders to receive “free” shares in the new company in a tax-free distribution.
• Dividends and Buybacks - Many activist shareholders like to push the parent company to then distribute their proceeds to shareholders in the form of one-time cash dividends or share buyback programs.
• Buyout Target - A spin-off reduces a parent company’s market cap, provides it with large amounts of cash, and helps get rid of some debt on its balance sheet. Activist investors will sometimes recommend these transactions to make the parent company a more attractive buyout target.

And spin-offs can also be an attractive investment opportunity for another reason too. Typically when spin-offs occur, shares are distributed automatically to all parent company shareholders - including mutual funds and other institutional holders. Now, many mutual funds have to abide by specific investment criteria based on market cap, revenues, and other metrics. Consequently, some institutional shareholders may be required to sell their new stock as soon as the spin-off becomes publicly traded. This windfall of unjustified selling creates an excellent buying opportunity for the enterprising investor. In fact, published studies have shown that spin-offs tend to outperform the overall market by a wide margin during their first year!

There are several types of spin-offs, including:

• Pure spin-offs are by far the most common in activist situations. These spin-offs involve the parent company selling off 100% of their stake in the business segment.
• Carve-outs are instances where the parent company will retain a non-majority portion of the new spin-off.
• Stubs are instances where company’s spin-off a minority interest in a business segment. Typically this is done to generate cash without giving up control.
• Tracking stocks are spin-offs that are designed specifically to track the value of their business segments.

All of the information regarding new spin-off issues can be found in Form 10-12B, which is filed with the Securities and Exchange Commission (SEC). Proposals to create spin-offs are often found in 8-K filings (when proposed by the company) or Schedule 13D filings (when proposed by activist investors). You can track these filings easily with e-mail and RSS alerts on SECFilings.com.