Spin Off, Buy Up, Cash In


By Pearl Wang After years of consolidation across Corporate America, boardrooms are abuzz with a new trend: deconsolidation, or spin-offs. In a spin-off, a company separates one of its subsidiaries or divisions to create an independent company, usually by distributing or selling the stock of it to the shareholders of the parent outfit.

In the coming months, Cendant (CD

; ranked hold by S&P; recent price: $17) will split itself into four separately traded companies; Viacom (VIA.B

; ranked hold; $37) will spin off CBS; McDonald's (MCD

; ranked buy; $32) will launch Chipotle as a separate stock; and Alloy (ALOY

; not ranked; $5) will spin off dELiA*s.

IN BLACK AND WHITE.A number of academic studies show that spin-offs outperform the market as well as their former parents. Stocks of spin-off companies outperformed peers and the Standard & Poor's 500 index by about 10% per year in the first 3 years of independence, according to a study published in 1993 by Penn State's Patrick J. Cusatis, James A. Miles, and J. Randall Woolridge, Restructuring Through Spinoffs, which examined 25 years of stock market history. That study also found parent companies of spin-offs also outperformed peers, by more than 6% yearly after the spin-off.

A 1999 McKinsey study of 168 large ownership restructurings, where the parent company had revenues of more than $200 million at the time of disaggregation, also showed that spin-offs substantially outperformed the market. The McKinsey study of outfits spun off between 1988 and 1998 showed that they put up a two-year annualized total return to shareholders of 27%, vs. 14% for the Russell 2000 and 17% for the S&P 500.

Why do spin-offs tend to outperform? In S&P's view, their shares tend be inexpensive initially because investors often sell when they receive stock in a new company they did not intend to own. Also, spin-offs are dumped by index funds when the new company is not in the original index, and institutional fund managers sell shares as a result of a spin-off's lack of liquidity or dividend.

However, insiders often receive generous incentives to make the spin-off work. And management of the newly spun-off company is frequently looking for ways to increase shareholder value, in S&P's view.

SARAH LEE'S SWEET MOVE. One successful spin off is Coach (COH

; ranked strong buy; $32). In October 2000, Sara Lee (SLE

; ranked hold; $18) spun off this luxury accessories business. Coach stock has soared more than 950% since then, vs. the S&P 500 index's 16% drop in the same period. Coach has expanded market share, increased its number of stores, and grown its Japanese joint venture, becoming one of the top accessories brands in Japan, a key market for luxury products.

By spinning off from Sara Lee, S&P thinks that Coach was able to unlock shareholder value. That's generally the reason companies choose to pursue spin-offs. For example, an outfit may separate a fast-growing segment to highlight its value. On Cendant's Oct. 24 investor conference call, CEO Henry Silverman described his reasons for pursuing a spin-off: "We anticipate that the separation of the four businesses will facilitate a clearer understanding and fairer market valuations of these businesses."

Spin-offs also help companies focus on individual businesses. A good example was the spin-off of Expedia (EXPE

; not ranked; $19) by IAC/InterActiveCorp (IACI

; ranked hold; $26), in August, 2005. IAC CEO Barry Diller's pitch to shareholders was: "Separating the company into two businesses will allow IAC to do what it does best, and Expedia to pursue its pure mission as a travel company."

REGULATORS' FIAT. A company can also potentially eliminate perceived problems through a spin-off. S&P believes that Altria (MO

; ranked buy; $75) spun off Kraft Foods (KFT

; ranked hold; $28) in 2001 to remove from the food business the taint of legal liabilities arising from tobacco-related lawsuits.

Sometimes, regulators require companies to spin off certain units in order to expand. Sprint's takeover of Nextel Communications to form Sprint Nextel (S

; ranked buy; $24) required Sprint to spin off its local telephone service as part of the deal's regulatory approval.

Here's a look at the upcoming spin-offs:

Cendant

The company announced on Oct. 24 that it will divide into four different companies. Cendant will spin off 100% of the equity of the three new companies to its shareholders in the summer of 2006.

One company will consist of Cendant's hospitality businesses, including the Ramada, Howard Johnson, and Days Inns hotel brands. The other three will focus on: real estate, including the Century 21 and Coldwell Banker brands; travel booking, including Orbitz, Galileo, and Cheap Tickets brands; and the Avis and Budget car-rental businesses.

Viacom

The media giant plans to split into two, one offshoot focusing on broadcast TV and the other on cable networks. The spin-off is expected to be completed in the first quarter of 2006. The new Viacom will be comprised of MTV Networks, BET, Paramount Pictures, Paramount Home Entertainment, and Famous Music. The other company, CBS Corp., will consist of the CBS and UPN broadcast networks, Viacom Television Stations Group, Infinity Broadcasting, Viacom Outdoor, the CBS, Paramount, and King World television production and syndication operations, as well as Showtime, Simon & Schuster, and Paramount Parks.

"The new Viacom and CBS will have highly complementary business portfolios, leadership positions in their industries, and superior management teams that have direct incentives to create greater shareholder value," says Sumner Redstone, chairman and CEO of Viacom. "In addition, each company will have distinct capital structures designed to generate higher returns."

McDonald's

The fast food giant filed a preliminary statement with the SEC on Oct. 25 to do a partial IPO of its casual restaurant chain Chipotle, in which McDonald's would retain a majority stake of Chipotle, distributing the rest to shareholders. "From McDonald's perspective, I think it's a pretty good idea to spin Chipotle off in order to focus on the core brand," says Dennis Milton, who follows restaurant stocks for Standard & Poor's Equity Research.

Alloy

The media, marketing services, and retail company targeting teenagers is spinning off its wholly owned subsidiary, dELiA*s. The spin-off will consist of Alloy's direct marketing and retail operations, which include dELiA*s, Alloy, and CCS brands. Alloy will keep its media and marketing units.

Each Alloy shareholder will receive one share of dELiA*s common stock for every two of Alloy's held on a to-be-determined record date. The exercise price in the subscription-rights offering has not been established, but will be based on a $175 million valuation for dELiA*s.

Wang is a reporter for S&P MarketScope


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