Editor's note: Spinoffs have beaten their parent companies time and time again... But it's unwise to buy just any spinoff. To make the most out of your investment, you need to understand all the aspects surrounding the separating business. Only then will you be best positioned to take advantage of the potential boom that could emerge. In today's Masters Series, adapted from a Market Maven special report, editor Gabe Marshank shares three tips for finding high-quality spinoffs...
Finding the 'Orphans' Who Can Surpass Their ParentsBy Gabe Marshank, editor, Market Maven When a company goes public via a traditional IPO, it selects a group of Wall Street banks to price its stock at a level that makes sure all the shares get sold. To help that process, the banks produce research, host analyst calls, and lead the companies on roadshows, all in an effort to drum up demand for the stock. The banks take a cut of the IPO proceeds. So, it should come as little surprise that research is almost universally positive. By the time an IPO is trading, everyone knows the stock's upside case. Spinoffs, on the other hand, make no money for Wall Street because the stock is handed directly to the shareholder. There is no IPO, and therefore no IPO proceeds to incentivize a bank to drum up interest. So, the banks don't bother paying attention to them, which means most spinoffs start trading with little to no analyst coverage. They are, in stock market terms, "orphans." As a result, the orphans are often overlooked and misunderstood. That doesn't just go for the Wall Street investment banks. Quite often, the money managers who actually receive the spun-off stock don't know what they own and dump the shares. We can use a real-world example to illustrate this...
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General Electric ("GE") is one of the country's most storied companies... but after a series of mergers and acquisitions in the 1980s and 1990s, it had fallen on hard times. Prior management stepped down, and the company was simplified through a series of sales and spinoffs. By 2024, GE was mostly an aerospace company, selling jet engines worldwide. But it still owned a smaller division that made turbines for power plants called GE Vernova (GEV), which it wanted to spin off to shareholders. At the time, GE sported a market value of $150 billion. When GEV was spun off, it made up just $35 billion of that. Fast-forward two and half years, and GE has done well, nearly doubling and growing its market cap to $290 billion. But again, the spinoff has dramatically outperformed... GEV is now a $265 billion company, up about 700% since the spinoff: 
Now, I can tell you from my own experience that money managers love a simple story. They owned GE for its dominant jet-engine franchise. Trying to figure out GEV would require learning a whole new industry because the customers were utilities rather than airlines. And at the time, GEV didn't make up a large portion of its parent company. It's usually easier to just sell the spinoff and move on. This tends to push the share price of the spinoff lower from the start. So, there are two reasons that spinoffs become great investment opportunities. One, investors who receive the spinoff after owning the parent company often don't have any interest in owning the spinoff, because they're smaller and usually in different lines of business. And two, unlike IPOs, there's no educational process (i.e., an investor roadshow) to find them a new home, so they become "orphans." That's a recipe for spinoffs to trade at prices that are just way too cheap... And it's a big reason why spinoffs consistently outperform their parents. That said... not all spinoffs are created equal. My first mentor on Wall Street was Larry Robbins, who went on to become the billionaire founder and portfolio manager of Glenview Capital Management. At the time, we were working at Omega Advisors under a different billionaire, Lee Cooperman. Robbins explained to me that there were a few different types of spinoffs, and that the reason a company was spun off mattered. He and I aggressively studied these situations. 1. Sometimes, it was so the parent company could dump a structurally weak business. This is, of course, the kind of spinoff you want to avoid. For example, in 2011, Sears Holdings – the parent company of department stores Sears and Kmart – tried to get rid of home-improvement chain Orchard Supply Hardware, only to see it quickly go bankrupt. Time (the company that houses publications such as People, Time, and Sports Illustrated) was spun out from Time Warner, fell totally flat due to challenges in publishing, and sold itself for a small fraction of its initial spinoff value. It goes without saying, but it's always a good idea to avoid a business in terminal decline – or what folks in the business like to refer to as a "melting ice cube." 2. Other times, a business is perfectly fine, but the parent company thinks it drags down the combined financials. This was the case when E.On, a German utility, decided to spin off its power-generation business as Uniper in 2016. Power generation isn't a sexy business, and at the time it was pretty depressed due to cyclically low energy prices. The parent company was tired of it and spun it off to shareholders, who largely dumped the stock. I convinced my boss at the time, David Einhorn, to invest more than nine figures into it... It paid off massively. The stock doubled in the next 18 months, and this obscure, little-known, downtrodden utility netted Greenlight more than $100 million in profits. I did the same with Dia, a Spanish convenience-store operator spun off by its French parent company. Dia was a forgotten business, now nimble and independent, with – most critically – a management team financially incentivized to push its share price higher. It's a recipe for a winning investment. And because this second situation is the reason behind most spinoffs, it's also why spinoffs tend to outperform their parents. But there's one last type of spinoff that's even better... 3. When a company is forced to spin off an asset it loves. There are plenty of examples of this in history, starting with the breakup of Standard Oil more than a century ago. Antitrust watchdogs at the time demanded a separation. The resulting 33 newly independent companies – including what became ExxonMobil (XOM), Chevron (CVX), BP (BP), and others – were smaller, nimbler, and able to improve their profits... and push their share prices higher. When AT&T (T) was forced to break up in 1984, the resulting seven "Baby Bells" turned into huge winners for investors. And as I mentioned yesterday, the eBay (EBAY) spinoff of PayPal (PYPL) only came from intense outside pressure applied by Carl Icahn. PayPal shares soared to their COVID-era peak before coming back down to Earth. Stocks like these meet the criteria that I'm looking for when I'm adding businesses to my portfolio. And if you want to find the best spinoffs on the market, I suggest you consider implementing the same guidelines. Regards, Gabe Marshank
Editor's note: A new flood of "orphans" could be on the horizon. Gabe has spotted the development of what he calls Investable Spinoffs. Because these companies will be forcefully sold off, Wall Street won't touch them, sending share prices far below their value. Gabe says this is the perfect opportunity to buy in. Once the rest of the market realizes the worth of these stocks, it's only a matter of time before they start to soar. Gabe's using the same strategy that made his former firm more than $100 million. To see it in action, click here. |
