Spin-Off Advisors, L.L.C. is an investment research boutique providing independent research on information poor, inefficiently priced spin-off situations. The firm was formed as an Illinois limited liability company in August 1998 and provides proprietary investment research for the investment professional focused on re-structuring situations. Money managers, mutual funds, banks, pension funds and hedge funds subscribe to our  proprietary research product "Spin-Off Research" which has been published since March 1997. Spin-Off Research is an extensive, monthly, institutional, advisory report, featuring continuous research on corpo-rate spin-off activity. Spin-Off Research is edited by Joe Cornell, CFA, and author of the book "Spin-Off To Pay-Off: An Analytical guide to Corporate Divestitures" (McGraw-Hill). Annual subscriptions are US$26,000.

General Thesis
"The Sum Of The Parts Is Greater Than The Whole"
Spin-Offs often result in a higher aggregate value for the constituent pieces. Many diversified companies are electing to spin off parts of their business, finding that this restructuring technique can create significant value for shareholders. Some of the reasons for spinning-off a company include a parent’s decision to withdraw from an industry or market due to lack of synergies or related core competencies, unsatisfactory performance of the spun-off entity, or superior margins of the spun-off entity. Newly independent companies are no longer con-strained by the overall strategic direction of their former parent. This independence forces them to develop their own roadmap for success. Spin-Off situations can be very rewarding. Investors can often achieve superior in-vestment performance from spin-offs for a variety of reasons. Institutional investors often shy away from spin-offs. Sometimes the spin-off does not meet the investor’s portfolio requirements. For example, the market capi-talization may be too small, a comparable company may already be represented in the portfolio, or the fund may be constrained by indexing requirements. This lack of initial sponsorship often creates a vacuum of down-ward pressure on the share price not attributable to business fundamentals. In effect, there is a temporary ineffi-ciency that can be captured by astute investors. When one reconstitutes that parent and spin-off after a one to two year period, often outstanding overall returns are observed.

Why Spin-Offs Prosper
Much of the impressive performance comes from the altered dynamics of the spun-off business and its parent. Spin-Offs do well partly because when a business and its management are freed from a large corporate parent, pent-up entrepreneurial forces are unleashed. The combination of accountability, responsibility and more direct incentives take their natural course. Managers have greater freedom to pursue new ventures, streamline produc-tion, and pare overhead. After the spin-off, stock options can more directly compensate management. This often leads to improved operating performance.

Types of Spin-Offs

Pure Spin-Offs
In a pure spin-off, a parent company distributes 100% of its ownership interests in a subsidiary operation as a dividend to its existing shareholders. After the spin-off, there are two separate, publicly held firms that have exactly the same shareholder base. This procedure stands in contrast to an initial public offering (IPO), in which the parent company is actually selling (rather than giving away) some or all of its ownership interests in a divi-sion. The spin-off process is a fundamentally inefficient method of distributing stock to people who may not necessarily want it. For the most part, investors were investing in the parent companies business. Once the shares are distributed, often they are sold without regard to price or fundamental value. This tends to depress the stock initially. In addition, institutions typically are sellers of spin-off stocks for various reasons (too small, no dividend, no research, etc.). Index funds are forced to sell the spin indiscriminately if the company is not included in a particular index. This type of selling can create excellent opportunities for the astute investor to uncover good businesses at favorable prices. Often, after the spin, freed from a large corporate parent, pent-up entrepreneurial forces are unleashed. The combination of accountability, responsibility, and more direct incen-tives (stock options) typically shows up in the operating performance post spin.

Carve-Outs (Partial Spin-Off)
In this case, the parent corporation sells to the public an interest of less than 20% in the new subsidiary in a SEC registered public offering (IPO) for cash proceeds. Often, an IPO in which the parent company retains a majority interest in the new company, may be a prelude to a spin-off of the remaining interests to existing shareholders. Companies utilize a partial spin-off strategy for a number of reasons. Sometimes a corporation may need to raise capital. Selling off a portion of a division while still retaining control may be an attractive option for a company. At other times the motivation for pursuing a partial spin-off is to highlight a particular division’s true value to the marketplace. Its value may be masked when buried among the parent company’s other businesses. A separate stock price for the division enables investors to value the division independently.

Stubs
Partial spin-off transactions occur when a corporation distributes shares in a subsidiary to the public while re-taining partial ownership. After a subsidiary becomes publicly traded, it is possible to determine the market value of the parent company’s investment in the subsidiary. By subtracting the subsidiary’s per-share value from the parent company’s per-share value, we will be able to isolate the implied value of the parent company’s core businesses— known as the "stub". The stub’s trading value can be at times less than its intrinsic value be-cause the true business value of the stub becomes obscured. We try to identify stub situations where the value is significantly in excess of its current implied value. It is possible to synthetically create a stub investment by purchasing the parent company’s stock and shorting its underlying subsidiaries (the carve-out). This methodol-ogy allows investors to capture the unrealized value of the stub, while simultaneously hedging market risk.

Tracking Stocks
Companies create these stocks to track the fortunes of one or more of their subsidiaries. We view tracking stocks as distant cousins to spin-offs. Unlike a spin-offwhere a division is separated from the parent, goes public, and has complete autonomy financially and managerially from the parent company-tracking stocks rep-resent shares that are still joined at the hip to the parent (there is no legal separation of the assets or liabilities). The parent and tracking stock operate under one management team and one board of directors, even though the tracking stock’s finances are reported separately from the parent. Companies issue tracking stocks to hopefully unlock value in their underlying subsidiary. Tracking stocks have some advantages (to the issuer) over spin-offs. Issuing tracking stocks is always a tax-free procedure and if either of the two units were losing money, the earnings from one would offset the losses of the other for tax purposes. Borrowing costs for the tracker are usually lower because it relies on its parent’s higher credit rating. Overhead costs are lower than if the two were separate. If synergies exist between the parent and the tracker, there are added benefits. As with spin-offs, the biggest reason for issuing tracking stock is the potential to goose the parent’s stock price. Companies often feel that Wall Street analysts and investors incorrectly value captive subsidiaries that are overshadowed by the parent. So investment bankers tell them that the creation of a tracking stock highlights “pure-plays” that can be valued higher by the market. This may prompt separate analyst coverage, and entice a different set of shareholders for the company. Tracking deals are our least favorite restructuring technique. Tracking stocks have inferior shareholder rights and the potential for serious conflict of interest issues. We believe the biggest drawback with tracking issues is that they are immune from takeovers. From an investor’s point of view, we would prefer to “own the thing that owns the thing”.

For more information please visit our web site at www.spinoffresearch.com.

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