If 2012 felt more spinoff-laden than usual, you’re not crazy — it was indeed chock full of corporate breakups.
You had Kraft Foods (NASDAQ:KRFT) splitting itself into its namesake organization and international-oriented Mondelez International (NASDAQ:MDLZ), Sears Holdings’ (NASDAQ:SHLD) semi-shady spinoff of Sears Hometown and Outlet Stores (NASDAQ:SHOS), and most recently, Abbott Laboratories’ (NYSE:ABT) separating its medical products and pharmaceutical divisions.
Those were hardly the only spinoffs (all in the name of “unlocking value,” mind you) undertaken of late, though. According to Forbes, 19 major corporate spinoffs have been executed in the past two years, vs. five in 2010 and only four in 2009. And 2012’s number of minor spinoffs is roughly twice the number of major ones.
Granted, in 2009 and 2010 — in the shadow of a painful recession — spinoffs and value were secondary; sheer survival was the only real goal. Still, even by long-term standards, the market has doled out far more spinoffs than usual of late, and investors have embraced the new companies with open arms.
That’s a habit they should drop sooner rather than later.
Some investors have loved all the recent spinoff action, as it theoretically makes both the spinnee and the spinner easier to love (i.e., it pumps up the stock price of each moreso than the combined company could muster on its own). Other investors, however, know there’s a less compelling reason for all the spinoffs … these breakups have been the only way some of these corporations have been able to deliver any real value to shareholders.
See, growth just hasn’t been the same since 2008; in fact, for some organizations, actual growth has been nonexistent. Sears Holdings, for instance, has seen a shrinking top line every year since 2008. Casting off Sears Hometown and Outlet Stores won’t prevent the bleeding of revenue; the retailer still needs to fix its bigger problem, which is carrying the wrong merchandise at the wrong time in the wrong way. The spinoff, however, has detracted from the company’s problems.
That’s a tough pill to swallow for some investors — especially the ones who’ve benefited from spinoff shares that have skyrocketed after being distributed.
Motorola comes to mind. In early 2011, Motorola Mobility and Motorola Solutions (NYSE:MSI) decided to go their separate ways, and the decision paid off handsomely for owners. Google (NASDAQ:GOOG) bought out Mobility at a 63% premium later that year, while MSI is up nearly 40% since the split’s announcement. For comparison, the broader market is up only 13% for the past couple of years. Motorola is an extraordinary case, though.
It all begs one question: If spinoffs are more showmanship than a value-add, why all the hype?
The answer: Investors love action (or at least the semblance of action), and corporate America’s top management — in an effort to justify their existence — have a bias for action (or at least the semblance of action). It just so happens that the current en-vogue action is spinoffs and breakups.
That’s not going to last forever, however. Indeed, spinoff-mania may be closer to its end than you could ever imagine.
The Deals Are Off
Again, spinoffs have only been red-hot since 2011. In the nine years before that (most of which were bullish), the market averaged just less than seven major spinoffs per year. During that period, the preferred weapon of choice for domestic companies was the acquisition … the diametrical opposite of a spinoff.
Dell (NASDAQ:DELL) could be considered a poster child for buyout-hungry companies. Since 2007, Dell has acquired about 15 companies. It might as well have acquired none. Not only have those purchases not beefed up the top or bottom line, but the company’s traditional computer business has stagnated. During Dell’s buying spree, however, the market loved the idea, certain all these new ventures would achieve some sort of synergy as the computer company fought its way out of the recession.
The point? Well, there are two.
- Investors were wrong about Dell’s acquisition tear, but at the time, they were cheering them on just like traders are cheering spinoffs on now. So, the market can be wrong.
- Everything is cyclical, including the strategic advantage of spinoffs. Though more will certainly try, not every company can unlock value by breaking itself up any more than other companies can unlock value by acquiring other business ventures.
Knowing that all things are cyclical, the bigger worry for investors now should be that spinoffs are no longer a proven way to make better-than-average returns, as the market’s best spinoffs are likely behind it and the proverbial cat is out of the bag.
And in retrospect, this spinoff mania has followed in the same footsteps as every other major market mania … the dot-com surge in the late ’90s, oil’s rally through 2008, gold’s current ascension, and the natural gas rally into 2008. They all started quietly, then slowly convinced everyone the trend was unstoppable. Just as the last of the masses were pouring their money into those “sure-fire” trends, those trends reversed.
While an abrupt reverse in the spinoff trend won’t pull the rug out from underneath traders as abruptly as natural gas and gold could — nor hurt as much — it still will dole out some disappointment when future spinoffs don’t pan out as well as Motorola’s did. Kraft and Mondelez, along with both Sears names, are apt to fall into that “disappointing” category.
And the deeper we go into 2013, the more lackluster the spinoffs will likely be, as most will be a desperate attempt to muster the appearance of progress rather than truly unlocking value.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.