PayPal Signals Overcrowded Spinoff Market Has Peaked: Real M&A

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Hopefully you enjoyed the spinoff boom -- because it may already be over.

The number of spinoff transactions is now dropping after reaching a peak of 87 globally in the final quarter of 2014, capping a record year, according to data compiled by Bloomberg. Only 64 were announced in the first three months of this year, followed by 51 from April through June.

Investors hungry for undiscovered opportunities with stocks near record highs have already piled in to many of the remaining spinoff candidates. Increased shareholder activism has also accelerated the flow of money into companies seen as ripe for breakups. That’s left little to be made after the spinoffs and is even spurring losses in some cases.

It’s become an overcrowded market, according to Jim Osman, who analyzes these types of transactions as chief executive officer of The Edge.

“People are greedy again, and they get greedy at tops,” he said in a phone interview. “Many of the spinoffs coming out are fully valued.”

The Bloomberg U.S. Spinoff Index continues to outperform the broader market, climbing 12 percent in the past 12 months. Still, that’s smaller than the gains the index recorded in the two previous 12-month stretches.

Among the recent disappointments are clothing brand Lands’ End Inc., steelmaker TimkenSteel Corp. and single-family home landlord Starwood Waypoint Residential Trust.

Spinoff ‘Fallacy’

Data from The Edge show that if an investor had bought all of the spinoff stocks that fit its criteria in 2013, that would have generated a 15 percent return. In 2014, it would have been just a 1 percent return. And this year, it becomes a loss.

“The perception that all spinoffs make money is an absolute fallacy,” Osman of The Edge said.

PayPal may be the next indicator that the market has topped. Osman predicts shares of the payment processor may decline when it begins trading separately from its parent EBay Inc. later this year. Takeover speculation has also contributed to frothiness around some spinoffs, including PayPal. Investors are already betting the business will get acquired by Google Inc. or Inc. soon after it becomes independent.

EBay’s valuation jumped earlier in June to as high as 15.4 times earnings before interest, taxes, depreciation and amortization, up from a multiple of 13.7 before shareholder Carl Icahn began pushing for a spinoff 17 months ago.

Other Options

Companies are increasingly considering options besides spinoffs. Many are opting to list units via an initial public offering rather than a tax-free spinoff to their own shareholders. Pfizer Inc. went that route with its animal-health business Zoetis Inc. It conducted an IPO for 17 percent of Zoetis in January 2013, then spun off the rest a few months later.

Barry Diller’s IAC/InterActiveCorp is also choosing an IPO for less than 20 percent of its online-dating unit.

The distinction between an IPO and a spinoff may seem like splitting hairs to some, but it can mean less of a chance for current shareholders to profit.

Sale Process

With mergers and acquisitions occurring near a record pace, there’s also incentive for companies to conduct private auctions for units to industry buyers.

Such a sale can still benefit shareholders because it brings in cash that can be used for buybacks or dividends. But if Pfizer had sold Zoetis instead of spinning it off, investors would have missed out on the 81 percent gain in Zoetis shares. There’s also speculation that Zoetis may get acquired, meaning its shareholders could end up receiving an acquisition premium, too.

Industrial conglomerate United Technologies Corp. has been weighing whether to sell or spin off its Sikorsky helicopter division. A sale is looking increasingly likely with the business now in a slump.

Opting for a sale can also raise money that the parent company may need to make purchases. Johnson Controls Inc., once the largest U.S. supplier of car parts, is exploring options for its auto unit. While that business is big enough and attractive enough to stand on its own, selling it would provide more cash for acquisitions to grow what’s left over. Johnson Controls has strategic holes in parts of the heating, ventilation and air-conditioning market, which could be filled by acquiring Lennox International Inc., a $4.8 billion company.

Buffett Critique

Warren Buffett, the world’s third-richest man, criticized spinoffs in his annual letter this year to Berkshire Hathaway Inc.’s shareholders. He denounced the deal cycle in which a fee-hungry “banking fraternity” urges acquisitions, only to later encourage their undoing for the sake of “unlocking shareholder value.”

There are still probably many companies that view their stocks as undervalued, said John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management. For that reason, spinoff activity should continue, he said.

“I’m in the camp that the market is fairly valued, so there’s nothing to stop companies from doing spinoffs as long as there are stock buyers who would like to play the particular theme that the spinoff company represents,” Manley said in a phone interview.

On Tuesday, Emerson Electric Co., a $37 billion company, said it plans to spin off its network power unit and explore alternatives for some of its other businesses.

Whether spinoffs keep happening at a brisk pace or not, mergers and acquisitions show no signs of slowing down and the IPO market is expected to heat up again. That means there will still be plenty of deal activity to chase.

Plus, there are still opportunities in the spinoff market, you just have to look harder, Osman said. One idea from him: Blackstone Group LP’s spinoff of its M&A and restructuring advisory business.

“Very few people know about it. Everyone’s heard of Blackstone but there’s no coverage” of the spinoff, he said. “That’s the sort of stuff we’re looking at.”