What Is a Spin Out?

A spin out is a type of corporate realignment involving the separation of a division to form a new independent corporation. The spin out company takes with it the operations of the segment and associated assets and liabilities. The parent company is required by the SEC to detail the spin out in Form 10-12B, which contains a substantial information letter or narrative that outlines the rationale for the spin out, strengths and weaknesses of the new company, and the outlook of its industry. A spin out, which is typically tax-free to shareholders, can take up to six months to complete.

Understanding Spin Outs

Spin outs can occur for a variety of reasons. The parent company might want to unlock the value of the embedded division, which might be growing at a different pace than the overall company. Usually, a trapped or constrained segment that's growing faster than its parent would be better off as an independent company.

A spin out allows the division being spun off to raise its own capital through issuing equity shares in the new company or debt in the form of bonds to fund the company's growth. The financing for raising capital might not be possible with the combined entity, but by separating out the profitable division, the spun off division has a greater chance of attracting investors and banks.

Spin outs can also help the parent company by allowing it to focus on its core operations without the diversion of resources to a segment that could have different needs in various aspects including operations management, marketing, finance, and human resources. Also, the division being spun out could have been established to create an ancillary service such as software or some needed technology. Although profitable, the technology division might not fit in with the industry of the parent company. As a result, it might be better to split them since the business plans and strategies of the parent company and the division might not align with each other.

A spin out could also occur if the division is not as profitable as the parent company. By creating a separate company, it removes the distraction of the struggling division. Also, a spin out could allow the management to sell off assets or look for a merger or buyout of the new company.

Parent companies often provide support for their spin outs by retaining equity in them or signing contractual relationships for the supply of products or services. In many cases, the management team of the spun out firm is drawn from the parent company as well.

Key Takeaways

  • A spin out is a type of corporate realignment involving the separation of a division to form a new independent corporation.
  • The spin out company takes with it the operations of the segment and associated assets and liabilities.
  • A spin out allows the division being spun off to raise its own capital through issuing stock and operate its own business strategy.

Some Drawbacks of a Spin Out

Investors are generally in favor of a spin out, as it makes business sense for a segment that has different needs and growth prospects to go it alone. The sum of the separated parts is usually greater than the whole for investors, as valuations over time have demonstrated. However, the spin out process can be costly in terms of management time and distraction for a number of months. Management's focus may shift from running the company to executing the spin out. Also, there can be significant transaction expenses to plan and complete a spin out.

Of course, there's no guarantee the spun out division will be profitable by itself. A spun out company could incur losses or poor earnings without the help of the parent. Conversely, removing a profitable division through spinning out, might leave the parent company with less revenue and vulnerable to poor financial performance.

Although spin outs are typically a positive sign for a company, investors might not like what remains at the parent company after the spin out and sell its stock.

Examples of Spin Outs

Spin outs are common, and investors have good reason to push for them. There are many notable spin outs including Mead Johnson Nutrition, which was spun out of Bristol Myers Squibb in 2009, Zoetis was spun out of Pfizer in 2013, and Ferrari was spun out of Fiat Chrysler in 2016.

Chipotle Mexican Grill

Chipotle Mexican Grill was spun out of McDonald's in 2006, whereby McDonald's reasons were "to push growth and devote more energy to its key businesses" as reported by the Denver Post. Chipotle's stock was offered at its initial public offering at $22 whereby 6 million shares were sold in 2006. As of the close of trading on June 7, 2019, Chipotle's stock was trading at $709.87 per share.

Delphi Technologies PLC

Delphi Automotive PLC spun out Delphi Technologies PLC, which became a $4.5 billion entity on December 5, 2017. The new company offers advanced propulsion systems, which according to the CEO, "the convergence of automated driving, increased electrification and connected infotainment, all enabled by exponential increases in computing power and smart vehicle architecture." Delphi Automotive became Aptiv PLC retained the powertrain business, the larger but slower-growing business. The spun out, Delphi Technologies PLC is in charge of its own destiny.

Old Navy

Clothing retailer Gap Inc. (GAP) announced in early 2019 that the company would spin out the division of Old Navy as reported by CNN. Old Navy will be an independent company. The Gap stores, including other brands such as Banana Republic, Hill City, and Athleta, will be one company. 

In 2018, Old Navy generated nearly as much revenue as all the other brands combined with its $8 billion in sales versus $9 billion in revenue from the Gap and the remaining stores. As a result of the spin out, Old Navy will be freed up to grow its brand under its own business plan and strategy according to senior executives at the company. The Gap and the remaining stores may consolidate since their sales have struggled to grow over the last few years.