Activists' Secret to Unlocking Value Falls Flat in Stock Marketby and
Returns for spinoff stocks are trailing the S&P 500 in 2015
Companies from Chemours to Talen Energy see their shares fall
From Carl Icahn to Barry Rosenstein, activists are in love with spinoffs as a way of unlocking stock market value. At the moment, they’re not working.
Emerson Electric Co. and RR Donnelley & Sons Co. are among American stocks that have declined an average of 1.1 percent in the month after announcing the actions this year -- the first negative return for that group since 2007, according to data compiled by Bloomberg. Companies from Chemours Co. to Talen Energy Corp. that have been carved out of corporate parents and handed to shareholders as separate securities are down 2.3 percent in 2015, trailing the Standard & Poor’s 500 Index.
Held up as a cure for ailing share prices by investors who say a company’s parts are worth more than the whole, spinoffs are struggling to live up to their billing after almost 80 were carried out since 2013. Companies created by the corporate action are in some cases being denigrated as unwanted baggage of the old economy or receptacles for debt.
“Investors are not anxious to jump on what could just be financial engineering,” said Alan Gayle, senior strategist for Atlanta-based RidgeWorth Investments, which oversees $40 billion. “Before, it was an offensive move where you had segments of companies that were growing very rapidly and they wanted to unlock potential from a valuation standpoint. Now the prospects are not as clear.”
Chief executive officers at U.S. firms are under growing pressure to find ways to keep the bull market going as earnings grind to a halt after six years of expansion. In addition to share buybacks and takeovers, they’ve turned to spinoffs as a way of focusing businesses or as a tactic for salvaging waning growth.
While not every corporate breakup involves a spinoff, the topic was thrust back into the news last week when billionaire investor Icahn disclosed an investment in American International Group Inc. and said it should split into three companies. The 79-year-old billionaire floated the idea in a letter made public on Oct. 28 as a way of limiting regulation spurred by its size. Almost $4 billion was added to its market value that day.
Earlier this year, Rosenstein’s Jana Partners called on Qualcomm Inc. to consider spinning off its chipset business as part of a strategic review of options to boost shareholder value.
It’s hard to see why activists are so excited about spinoffs, based on trading in 2015. In a Bloomberg index that tracks deals with a value of more than $1 billion, 14 newly minted companies have lost an average 8.6 percent since being listed, while their parents declined 2.4 percent.
Among the disappointments are PayPal Holdings Inc. and Talen Energy. Shares of PayPal have slipped 1.9 percent since EBay Inc. broke off the payments business, bowing to pressure from Icahn. Talen Energy has tumbled 58 percent after PPL Corp., the power company in Allentown, Pennsylvania, separated it to refocus on its “high performing” utility assets.
DuPont split up its less profitable chemicals business as Chemours, and its stock has dropped 4.4 percent. The former unit is down 67 percent after taking on some of the parent’s environmental liabilities and inheriting a debt load to help DuPont fund buybacks. Energizer Holdings Inc. and Baxalta Inc. took out borrowings of at least $600 million to finance a payment to their parent companies.
“We’re seeing more of these forced company spinoffs,” said Jonathan Morgan, an analyst for Edge Consulting Group LLC, a Morristown, New Jersey-based research firm that analyzes spinoffs and special situations. “Because companies are doing poorly, there are more activists, and more activists forcing spinoffs, moving further away from value spins.”
A representative of Icahn didn’t immediately respond to a request for comment while one for Rosenstein declined to comment.
Even as valuations sit near two-year highs, only two of this year’s spinoff parents are expected to report an increase in earnings next year, analyst estimates compiled by Bloomberg show. At its June peak, the Bloomberg Spin-Off Index was trading at 21.3 times earnings, a 14 percent premium over the S&P 500.
Spinoffs still represent good investment opportunities, especially those driven by business considerations rather than activist investors, according to Joe Cornell, an analyst at Spin-Off Advisors LLC, an equity research firm in Chicago. The Bloomberg Spin-Off Index had advanced more than 17 percent a year from its 2002 inception through 2014, almost double the gain in the S&P 500.
Vista Outdoor Inc., a sports and recreation company, and Cable One Inc., a former unit of Graham Holdings Co., are among this year’s winners, climbing at least 8 percent.
“Not all spinoffs make sense, but as a group they’ve tended to provide a lot of excess returns relative to the market. That’s a good pond to fish in,” Cornell said. “To the extent that the companies are doing spins voluntarily rather than doing them under duress with guys leaning on them to do it, it’s better if they see the break-up value rather than having someone beat them up to try to do that to take value out over a short-term basis.”
Madison Square Garden Co., yielding to an initiative led by investor John A. Thaler’s JAT Capital Management LP to boost value, broke up its slowing sports and entertainment businesses from the media operations. Shares of the parent company have dropped 12 percent since the September split.
Among some 30 companies in the Russell 3000 Index that have expressed spinoff plans since January, almost 60 percent fell over the following month. The post-announcement decline of 1.1 percent is a reversal from an increase of 4.3 percent in 2014 and compares with an average return of 1.9 percent since 2005, data compiled by Bloomberg show.
Yum! Brands Inc. shares have dropped 2.9 after an announcement last month that it would break up its China business, heeding calls from hedge fund manager Keith Meister. Air Products & Chemicals Inc., an industrial-gas producer targeted by activist investor Bill Ackman, has slipped 3.3 percent after saying in September that it plans to separate its materials technologies unit.
“They’re not going out of fashion, and everyone is going to continue to focus on them. But it’s not the case anymore that you can do a blanket investment of spinoffs in the market,” Morgan said. “Hedge funds have to earn a buck for clients, especially activists. It’s affecting the quality.”