What Is a Spinoff?
When a company creates a new independent company by selling or distributing new shares of its existing business, this is called a spinoff. A spinoff is a type of divestiture. A company creates a spinoff expecting that it will be worth more as an independent entity. A spinoff is also known as a spinout or starburst.
- A spinoff is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company.
- The spun-off companies are expected to be worth more as independent entities than as parts of a larger business.
- When a corporation spins off a business unit that has its own management structure, it sets it up as an independent company under a renamed business entity.
A parent company will spin off part of its business if it expects that it will be lucrative to do so. The spinoff will have a separate management structure and a new name, but it will retain the same assets, intellectual property, and human resources. The parent company will continue to provide financial and technological support in most cases.
A corporation creates a spinoff by distributing 100% of its ownership interest in that business unit as a stock dividend to existing shareholders. It can also offer its existing shareholders a discount to exchange their shares in the parent company for shares of the spinoff. For example, an investor could exchange $100 of the parent’s stock for $110 of the spinoff’s stock. Spinoffs tend to increase returns for shareholders because the newly independent companies can better focus on their specific products or services.
Why Spinoffs Happen
A spinoff may occur for various reasons. A company may conduct a spinoff so it can focus its resources and better manage the division that has more long-term potential. Businesses wishing to streamline their operations often sell less productive or unrelated subsidiary businesses as spinoffs. For example, a company might spin off one of its mature business units that are experiencing little or no growth so it can focus on a product or service with higher growth prospects.
Alternatively, if a portion of the business is headed in a different direction and has different strategic priorities from the parent company, it may be spun off so it can unlock value as an independent operation.
A company may also separate a business unit into its own entity if it has been looking for a buyer to acquire it but failed to find one. For example, the offers to purchase the unit may be unattractive, and the parent company might realize that it can provide more value to its shareholders by spinning off that unit.
Both the parent and the spinoff tend to perform better as a result of the spinoff transaction, with the spinoff being the greater performer.
The downside of spinoffs is that their share price can be more volatile and can tend to underperform in weak markets and outperform in strong markets. Spinoffs can also experience high selling activity; shareholders of the parent may not want the shares of the spinoff they received because they may not fit their investment criteria. The share price may dip in the short term because of this selling activity, even if the spinoff’s long-term prospects are positive.
Spinoffs are a common occurrence; there are typically dozens each year in the United States. Recent examples include the 2020 spin off of Smith & Wesson from American Outdoor Brands or the separation of PayPal from its parent company eBay.
Why Would a Company Initiate a Spinoff?
The main reason for a spinoff is that the parent company expects that it will be lucrative to do so. Spinoffs often increase returns for shareholders, as the newly independent companies can prioritize specific products or services. A company may conduct a spinoff to focus its resources and better manage the division that has greater long-term potential, if a segment of the company is moving in a new direction and has different strategic priorities from the parent company, or if the parent has been searching for a buyer to acquire that division of its business but previously failed to find one.
How Is a Spinoff Done?
A company can create a spinoff by distributing the entirety of its ownership interest in that business unit as a stock dividend to existing shareholders, in addition to offering its existing shareholders a discount to exchange their shares in the parent company for shares of the spinoff. The spinoff will receive its own name and a separate management structure, though it will retain its original assets, intellectual property, and human resources. The parent company will usually continue to provide financial and technological support.
What Are the Disadvantages of a Spinoff?
The biggest downside of a spinoff is that its share price tend to be more volatile, in addition to typically underperforming in weak markets and outperforming in strong markets. Since shareholders of the parent may not want the shares of the spinoff they received in their portfolios, they can also experience high selling activity. As a result, the spinoff's share price may dip in the short term, even if the company has good long-term prospects.