What Corporate Spinoffs Mean for Investors

Q: What is a spinoff?

A: A corporate spinoff is a little like a television spinoff. Think Saul, the popular lawyer character from Breaking Bad who became the lead in a new show titled Better Call Saul, or Frasier from Cheers and The Colbert Report from The Daily Show with Jon Stewart.

In the corporate world, companies create spinoffs by separating a portion of their business to create a new, independent entity.

Here's a look at why companies sometimes spin off operations, how they work, and what they can mean for investors who own stock in the original company.

Spinoff 101

To spin off part of its operations, one company creates a new company. The new entity typically keeps its employees, business strategy, products, services, assets and intellectual property. It will be subject to the financial reporting requirements that come along with being its own publicly traded business and could add any staff or operational elements that weren't included in the split — human resources or legal teams, for example.

The new company takes on a new name and ticker symbol since it will trade independently on a stock exchange. It's this new name and ticker symbol that you might see in the media or on your trading platform when the spinoff happens. Here's how the process could play out for an investor.

• A company announces plans to spin off a portion of its business (a unit, segment or division)
• The original, or parent, company typically distributes shares of the spinoff to its existing shareholders
• Shareholders might receive this distribution as a stock dividend, which is a payment made in shares instead of cash
• If you own stock in the parent company, you would automatically receive shares in the new company
• The amount of shares you'd receive would be proportional to the number of parent-company shares you own
• Investors may be offered an opportunity to exchange shares in the parent company for shares in the spinoff. This is typically optional, and the spinoff shares may be offered at a discount (for example, $1,000 in parent company shares exchanged for $1,500 in spinoff shares)
• Some spinoff deals also offer shareholders warrants, which would give them the right to buy more shares of the spinoff company at a predetermined price and within a specific timeframe

Spinoffs: Pros and Cons for Investors

When you own stock in a company that announces a spinoff, you can have a few decisions to make. First, you can decide to hang on to the new stock and see how it performs, or you can sell it right away. After the distribution, you own stock in a company you didn't intentionally add to your portfolio. For this reason alone, some investors may choose to exit the position if the new company doesn't fit within their overall investment strategy. Others may be curious about the spinoff and maintain the position while they learn more. Warrants require additional decisions. Exercise? If yes, when? Let them expire?

As with all investment decisions, these are personal and based on your unique goals and portfolio strategy. However, understanding why a spinoff occurred may provide you with context to help with your decisions.

Why Do Spinoffs Happen?

There are a number of reasons why a company might decide to spin off a portion of its operations. Here are a few examples:

• A company that wants to be acquired or merge with another firm might spin off a part of the business that has proven a deterrent to potential buyers
• Alternatively, if a company wants to sell a specific segment of the business, it might spin it off to sell is separately and keep the remaining segments intact
• If one segment is underperforming, spinning it off can increase the value and potential of the parent by getting rid of a weak spot
• Alternatively, if one segment is outperforming, it may be beneficial to give it room to grow unencumbered by the parent

Each of these scenarios could demonstrate potential strength or weakness of the parent or the spinoff. These can be complex deals and should each be evaluated on its own merits.