Ebay shareholders like the company’s recent decision to spin-off payment processor PayPal. Its shares are up by almost 8% since the news broke. Investors in other companies should take note. Recent research shows that spin-offs are better for shareholders than trade sales—and for reasons that may surprise.
According to Boston Consulting Group, investors reward spin-offs more than a direct sale of a company’s assets, even though spin-offs often do not generate cash for shareholders. Almost 60% of spin-offs since 1990 generated positive cumulative abnormal returns (or returns in excess of the broader market), versus about 54% of the trade sales. The average seven-day return (what BCG also considers the accurate reflection for longer term direct effects on the stock price) for spin-offs was 2.6%, double the amount generated from the sale of a company.
BCG offers several suggestions to explain why shareholders prefer spin-offs to trade sales. First, spin-offs are cleaner. They typically have no financing requirements or other cash constraints. Shareholders understand what they are receiving, and when they will receive it. Second, proceeds from trade sales are often subject to corporate taxes while spin-offs are not. Third, a spin-off gives management teams at both companies more freedom to focus on their businesses and make decisions without taking on the risk of integrating another firm’s strategy. (For example it is broadly believed that, after the spin-off, PayPal will have more freedom to focus on reshaping its business as a standalone company.)
Perhaps most important of all, Berlin-based BCG partner Alexander Roos argues that in a spin-off, a company doesn’t have an incentive to “oversell” the value of its assets. An aggressive trade sale may appear to help shareholders in the short run, but “most transactions today are not structured to give a lump sum to shareholders.” Instead, they might receive some cash but also stock in the new company. Shareholders understand that “this can lead to a counter reaction,” meaning, if an acquirer overpaid for a company, the seller’s shareholders are also receiving shares in a new company that effectively destroyed value with an overpriced purchase. Stock prices at the onset of the deal reflect this uncertainty in valuation.
Conversely, in a spin-off, a company often has more incentive to do a fair trade. “They split up a company into two, but it goes to the shareholder base they already have. The management has a more rigorous discussion around the relative pricing.”