Spin-off: Encyclopedia II - Spin-off - Corporate Spinoffs

Spin-off - Corporate Spinoffs

Many times in the business world, companies "spin off" their operations. For example, a company that makes ice cream and makes cars might split up into a company that makes cars, and a company that makes ice cream. The current owners (the shareholders) of the company would own stock in both the company that makes cars, and the company that makes ice cream.

The primary and nearly exclusive reason why this is done is due to the phenonemon of stock valuation. People who buy stock make money in two different ways, via dividends, and via selling the stock at a higher price then when they bought it originally. The goal of all publically traded companies then is to pay dividends and/or attempt to increase the value of their stock price. Many academics and investors believe that the stock price of a company over the long term is most strongly influenced the profits the company makes. However, the price people will be willing to pay for a companies stock relative to its profits (known as the PE ratio) is widely believed to differ depending on certain characteristics of the company. For example, fast growing companies are seen to be able to command a higher price relative to their current earnings, because it is felt that their profits will grow quickly enough to repay that price. Companies that have steady but small increases in profit are believed to be more valued then ones that have wild swings in profitability, because the swings in profitability can create swings in the stock price making it more likely that the price will be temporarily down when one needs to sell the stock. In the same way, whole industries are seen to command a higher price relative to their earnings when compared with other industries.

Because of these widespread beliefs about stock valuation, company managers sometimes contemplate splitting their companies if they believe that "whole is less then the sum of its parts". For example, lets say that ice cream companies are generally valued at 15 times their profits (say for example because there is a big ice cream company trend hitting the country), and car companies are valued at 10 times their profits (because the car industry is seen as a slow growing industry). There is a icecream/car conglamerate which has stock selling at 50 dollars a share, 10 times the amount of its profits of 5 dollars a share (half of its profits come from ice cream and half from cars). This company then splits into two, with its current stock holders getting a car company for 25 dollars a share, and an ice cream company for 25 dollars a share. The managers doing this hope that others will bid up the price of the ice cream company to 37.50 (15 times their profits) as is the norm for the ice cream industry. In this way, the original stock holder who had a share for 50.00's now has 2 shares which total 87.50 dollars.

Adapted from the Wikipedia article "Corporate Spinoffs", under the G.N U Free Docmentation License. Please also see http://en.wikipedia.org/wiki