>Value Investing? Hunt for SPIN-OFF's..!!

Lets think more..!!!

A great idea from the famous book is investing wisely in Spin-Off's.

In an investment classic “You can be a Stock Market Genius”, the author, Joel Greenblatt, writes about spinoffs.

“The first investment area we'll visit is surprisingly unappe­tizing. It's an area of discarded corporate refuse usually re­ferred to as "spinoffs." Spinoffs can take many forms but the end result is usually the same: A corporation takes a sub­sidiary, division, or part of its business and separates it from the parent company by creating a new, independent, free­standing company. In most cases, shares of the new "spinoff" company are distributed or sold to the parent company's ex­isting shareholders.

There are plenty of reasons why a company might choose to unload or otherwise separate itself from the fortunes of the business to be spun off. There is really only one reason to pay attention when they do: you can make a pile of money investing in spinoffs. The facts are overwhelming. Stocks of spinoff companies, and even shares of the parent companies that do the spinning off, significantly and consis­tently outperform the market averages.

One study completed at Penn State, covering a twenty­-five-year period ending in 1988, found that stocks of spinoff companies outperformed their industry peers and the Stan­dard & Poor's 500 by about 10 percent per year in their first three- years of independence. The parent companies also managed to do pretty well-outperforming the companies in their industry by more than 6 percent annually during the same three-year period. Other studies have reached simi­larly promising conclusions about the prospects for spinoff compames.

What can these results mean for you? If you accept the as­sumption that over long periods of time the market averages a return of approximately 10 percent per year, then, theo­retically, outperforming the market by 10 percent could have you earning 20-percent annual returns. If the past ex­perience of these studies holds true in the future, spectacu­lar results could be achieved merely by buying a portfolio of recently spun-off companies. Translation: 20-percent an­nual returns-no special talents or utensils require.

But what happens if you're willing to do a little of your own work? Picking your favorite spinoff situations-not merely buying every spinoff or a random sampling - should result in annual returns even better than 20 percent. Pretty signifi­cant, considering that Warren Buffett, everyone's favorite bil­lionaire, has only managed to eke out 28 percent annually (albeit over forty years). Is it possible that just by picking your spots within the spinoff area, you could achieve results rival­ing those of an investment great like Buffet?

Nah, you say. Something's wrong here. First of all, who's to say that spinoffs will continue to perform as well in the future as they have in the past? Second, when everyone finds out that spinoffs produce these extraordinary returns, won't the prices of spinoff shares be bid up to the point where the extra returns disappear? And finally-about these results even greater than 20 percent-why should you have an edge in figuring out which spinoffs have the greatest chance for outsize success?

0ye of little faith. Of course spinoffs will continue to out­perform the market averages-and yes, even after more peo­ple find out about their sensational record. As for why you'll have a great shot at picking the really big winners-that's an easy one-you'll be able to because I'll show you how. To un­derstand the how's and the why's, let's start with the basics.

Why do companies pursue spinoff transactions in the first place? Usually the reasoning behind a spinoff is fairly straightforward:

Ø Unrelated businesses may be separated via a spinoff transaction so that the separate businesses can be better appreciated by the market.

For example, a conglomerate in the steel and insurance business can spin off one of the businesses and create an in­vestment attractive to people who want to invest in either in­surance or steel but not both.

Of course, before a spinoff, some insurance investors might still have an interest in buying stock in the conglom­erate, but most likely only at a discount (reflecting the "forced" purchase of an unwanted steel business).

Ø . Sometimes, the motivation for a spinoff comes from a desire to separate out a "bad" business so that an unfet­tered "good" business can show through to investors.

This situation (as well as the previous case of two unrelated businesses) may also prove a boon to management. The "bad" business may be an undue drain on management time and focus. As separate companies, a focused manage­ment group for each entity has a better chance of being ef­fectiv
e.

Ø Sometimes a spinoff is a way to get value to shareholders for a business that can't be easily sold.

Occasionally, a business is such a dog that its parent com­pany can't find a buyer at a reasonable price. If the spinoff is merely in an unpopular business that still earns some money, the parent may load the new spinoff with debt. In this way, debt is shifted from the parent to the new spinoff company(creating more value for the parent).

On the other hand, a really awful business may actually receive additional capital from the parent- just so the spin­off can survive on its own and the parent can be rid i.

Ø Tax considerations can also influence a decision to pur­sue a spinoff instead of an outright sale.

If a business with a low tax basis is to be divested, a spinoff may be the most lucrative way to achieve value for share­ holders. If certain IRS criteria are met, a spinoff can qualify as a tax-free transaction - neither the corporation nor the in­dividual stockholders incur a tax liability upon distribution of the spinoff shares.

A cash sale of the same division or subsidiary with the proceeds dividended out to shareholders would, in most cases, result in both a taxable gain to the corporation and a taxable dividend to shareholders.

Ø A spinoff may solve a strategic, antitrust, or regulatory is­sue, paving the way for other transactions or objectives.

In a takeover, sometimes the acquirer doesn't want to, or can't for regulatory reasons, buy one of the target company's businesses. A spinoff of that business to the target company's shareholders prior to the merger is often a solution. In some cases, a bank or insurance subsidiary may subject the parent company or the subsidiary to unwanted regula­tions. A spinoff of the regulated entity can solve this problem
.

The list could go on. It is interesting to note, however, that regardless of the initial motivation behind a spinoff transac­tion, newly spun-off companies tend to handily outperform the market. Why should this be? Why should it continue?

Luckily for you, the answer is that these extra spinoff prof­its are practically built into the system.

=>The spinoff process itself is a fundamentally inefficient method of distributing stock to the wrong people. Generally, the new spinoff stock isn't sold, it's given to shareholders who, for the most part, were investing in the parent company's business. Therefore, once the spinoff's shares are distributed to the parent com­pany's shareholders, they are typically sold immediately without regard to price or fundamental value.

=>The initial excess supply has a predictable effect on the spinoff stock's price: it is usually depressed. Supposedly shrewd institutional investors also join in the selling. Most of the time spinoff companies are much smaller than the parent company. A spinoff may be only 10 or 20 percent the size of the parent. Even if a pension or mutual fund took the time to analyze the spinoff's business, often the size of these compa­nies is too small for an institutional portfolio, which only con­tains companies with much larger market capitalizations.

=>Many funds can only own shares of companies that are included in the Standard & Poor's 500 index, an index that includes only the country's largest companies. If an S&P 500 company spins off a division, you can be pretty sure that right out of the box that division will be the subject of a huge amount of indiscriminate selling. Does this practice seem foolish? Yes. Understandable? Sort of. Is it an opportunity for you to pick up some low-priced shares? Definitely.

=>Another reason spinoffs do so well is that capitalism, with all its drawbacks, actually works. 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. After a spinoff, stock options, whether issued by the spinoff company or the parent, can more directly compensate the managements of each business. Both the spinoff and the parent company benefit from this reward system.

In the Penn State study, the largest stock gains for spinoff companies took place not in the first year after the spinoff but in the second. It may be that it takes a full year for the initial selling pressure to wear off before a spinoff's stock can perform at its best. More likely, though, it's not until the year after a spinoff that many of the entrepreneurial changes and initiatives can kick in and begin to be recognized by the marketplace.

Whatever the reason for this exceptional second-year performance, the results do seem to indicate that when it comes to spinoffs, there is more than enough time to do research and make profitable investments.

One last thought on why the spinoff process seems to yield such successful results for shareholders of the spinoff company and the parent: in most cases, if you examine the motivation behind a decision to pursue a spinoff, it boils down to a desire on the part of management and a com­pany's board of directors to increase shareholder value. Of course, since this is their job and primary responsibility, the­oretically all management and board decisions should be based on this principle. Although that's the way it should be, it doesn't always work that way.

It may be human nature or the American way or the nat­ural order of things, but most managers and boards have tra­ditionally sought to expand their empire, domain, or sphere of influence, not contract it. Perhaps that's why there are so many mergers and acquisitions and why so many, especially those outside of a company's core competence, fail.

Maybe that's why many businesses (airlines and retailers come to mind) continually expand, even when it might be better to return excess cash to shareholders. The motives for the ac­quisition or expansion may be confused in the first place. However, this is rarely the case with a spinoff. Assets are be­ing shed and influence lost, all with the hope that share­holders will be better off after the separation.

It is ironic that the architects of a failed acquistion may well end up using the spinoff technique to bail themselves out. Hopefully, the choice of a spinoff is an indication that a degree of discipline and shareholder orientation has returned. In any case, a strategy of investing in the shares of a spinoff or parent company should ordinarily result in a pre­-selected portfolio of strongly shareholder-focused com­panies.

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amazing things people think...!!
Hope I am spared for the copy-paste.
I love this. :-)