A company may spin off a subsidiary into a separate company if it believes the process will create more value for either the parent company, the spinoff company, or both. In some cases, company executives, board members, or major shareholders may recommend a spinoff if they feel the subsidiary is not a good fit under the parent company’s guidance, and could thrive as a separate company with independent leadership. Another common example for when a company may initiate a spinoff is if the parent company had tried to sell the division of the business, but it failed. A spinoff would allow the company to reorganize the structure of the subsidiary, and perhaps enhance its performance. A notable example from recent years is the 2015 spinoff of PayPal from its parent company eBay Inc. In this scenario, eBay Inc. stockholders received one share of PayPal common stock for each share of eBay Inc. common stock as held at the close of business on July 8, 2015—the record date for the distribution of PayPal shares. EBay initially acquired PayPal in 2002 in what was then viewed as a synergistic match of two businesses—one as an online auction company and the other as an online payments company. Over time, as the markets changed and PayPal grew in popularity, eBay decided to pursue a spinoff. In a message to eBay investors when the spinoff was near, John Donahoe, who was then the CEO and president of eBay, stated, “Going forward, eBay and PayPal will each have a sharper focus and greater flexibility to pursue future success in their respective markets.” PayPal was growing faster than its parent company at the time of the spinoff, and continued to do so in the years that followed. As of Oct. 5, 2021, PayPal’s market capitalization was $307.5 billion, while eBay’s market cap was $45.8 billion.
How a Spinoff Works
State law and rules of the stock exchanges determine if a company must seek shareholder approval for a spinoff. There also are many regulatory and legal issues that may come with a spinoff depending on multiple factors. A subsidiary must register a spinoff of shares under the Securities Act if the spinoff is a “sale” of the securities by the parent. The U.S. Securities and Exchange Commission (SEC) states the spinoff does not have to register under the Securities Act if the following conditions are met:
The parent shareholders do not provide consideration for the spinoff shares.The spinoff is pro rata to the parent shareholders.The holding company provides adequate information about the spinoff and the subsidiary to its shareholders and to the trading markets.The parent company has a valid business purpose for the spinoff.If the parent company spins off “restricted securities,” it has held those securities for at least two years.
Pros and Cons of a Spinoff
Pros Explained
Increased focus from management: A spinoff often gives the parent company and the new company the chance to start anew. It can enable the leadership teams of both the businesses to hone in on their resources and create more narrowly focused strategies. Reduced risk or debt: While under the holding company, a subsidiary may require significant investment in research, development, marketing, and other expense areas. Separating it from the parent company can isolate the costs or risks of the new spinoff company. Conversely, a parent company may have extensive debt that is dragging down the performance of a division. Initiating a spinoff can isolate the debt to the parent company and not affect the spinoff company’s balance sheet. Reduced overhead: Following a spinoff, the parent company is no longer responsible for agency costs or other expenses the spinoff company incurs. It is completely its own entity, which may give both companies more financial freedom. Potential growth or performance improvement: According to August 2021 research from Barclays, nearly 60% of spinoff companies traded at a multiple greater than their parent companies post-transaction, and about half had margins exceeding those of their parent companies.
Cons Explained
Costs to the parent company: Costs related to a spinoff may include legal fees, taxes, functional costs related to the separation, and potential employee-related costs such as relocation. Employee discomfort: When a spinoff occurs, many employees of the parent company may either be transferred to the new company, or potentially let go. When a spinoff is taking place, employees may have anxiety or feel pushed out, ultimately changing the atmosphere of the workspace. Loss of identity: A spinoff can leave the newly created company struggling to establish a corporate identity. However, escaping a corporate identity can be part of the intent of a spinoff, as it was when Google created a new parent company, Alphabet. The company created a new parent company identity because it had grown to include divisions well beyond the search engine function its original name had become synonymous with.
What It Means for Individual Investors
Long-term studies of how spinoffs affect stock performance indicate that shares of both the parent company and the spinoff company outperform benchmarks, at least for a year or more. Of course, there is no guarantee that either a parent company or a spinoff company will fare well. As with any investment decision, it is important to analyze how a spinoff may impact both the parent company and the newly created company, and determine what fits your investment strategy. It may lead to a decision to allocate your money into one or the other company, hold on to shares of both, or divest your shares in the entities.
