This feature explores spin-offs or de-mergers, looking at the rationale for them and how they have performed, and asks if they can be a promising hunting ground for investors.

One of the UK’s largest recent spin-offs was GSK’s (GSK) demerger of its consumer healthcare division in 2022.

GSK reportedly rebuffed a £50 billion offer from personal goods giant Unilever (ULVR) to buy the division, named Haleon (HLN), in the autumn of 2021.

The GSK board instead decided to spin the business off to its own shareholders and the shares began trading at 330p per share on 18 July 2022, valuing the business at roughly £31 billion, way below Unilever’s offer.

In a twist of fate, Unilever’s new management team has announced it now wants to spin off its ice cream division (19 March) as the fast-moving consumer goods group looks to accelerate its growth plan aimed at increasing shareholder returns.

YET TO DELIVER

Haleon was the largest new listing on the London Stock Exchange since mining group Glencore (GLN) came to the market in May 2011 with a market cap of around £37 billion, according to Refinitiv data.

Almost two years on from their debut, Haleon shares trade close to their listing price but the combined market cap of Haleon and GSK today is approximately a tenth below where it was at the time of the separation meaning investors have so far seen no benefit from the demerger.

That isn’t how demergers are supposed to work, but it does demonstrate the wide dispersion in outcomes when companies spin off parts of their business.

One of the most successful spin-offs of all time is advanced semiconductor equipment maker ASML (ASML:AMS), which was hived off from its Dutch parent Philips (PHIA:AMS) in 1994.

Since listing, ASML shares have increased 367-fold which is equivalent to a compound annualised return of 22.6% per year.

Global information services company Experian (EXPN) is one of the best-performing UK de-mergers, delivering a share price return of 10% per year since it spun out of GUS (Great Universal Stores) in 2006. 

GUS no longer exists as a company as its Argos catalogue retail division now resides within supermarket group Sainsbury’s (SBRY) and its iconic fashion brand Burberry (BRBY), which started life as a mail-order business in Manchester over a century ago, is separately listed. 

One of the worst-performing demergers in recent times is home improvement retailer Wickes  (WIX), which was spun out of Travis Perkins (TPK) in April 2021.

The share prices of both companies have suffered due a slowdown in the home improvement market with the former down 38% and the latter down by 50% since the split.

WHY SPIN OFF IN THE FIRST PLACE?

Where a company operates a conglomerate structure with a mishmash of unrelated businesses, the value of the group can be less than the sum of its parts as investors often apply a conglomerate discount.

The aim of a spin-off is to increase the share price of the parent and create greater shareholder value for both sets of shareholders.

Demerging a subsidiary business allows investors to get a clearer picture of its true value, which can subsequently lead to a higher valuation over time than its implied value inside the parent company.

There is an argument to suggest demerged businesses tend to be better managed as the directors are responsible for their own profit and loss account and are incentivised to create shareholder value.

Unshackled from the parent, a demerged business is free to follow its own path and drive its own destiny, potentially becoming more innovative and driving faster growth.

NOTABLE US AND UK SPIN-OFFS

The US market has a rich history of spin-offs, from the break-up of AT&T (T:NYSE) or ‘Ma Bell’ as it was known in the 1980s to eBay’s (EBAY:NASDAQ) split with PayPal (PYPL:NASDAQ), Altria’s (MO:NYSE) divestment of Philip Morris International (PM:NYSE) and Abbott Laboratories (ABT:NYSE) spinning off its biopharma business AbbVie (ABBV:NYSE).

More recently, US pharmaceutical firm Johnson & Johnson (JNJ:NYSE) followed in GSK’s footsteps by spinning out its own consumer healthcare division Kenvue (KVUE:NYSE) in August 2023, generating $13.2 billion in cash for the parent.

The trend to demerge healthcare businesses continues apace. Diversified technology firm 3M (MMM:NYSE) spun off its healthcare unit Solventum (SOLV:NYSE) in March 2024. The company operates four divisions ranging from wound care, dental solutions, purification, and filtration to hospital software.

In October 2023, Corn Flakes and Special K cereal maker Kelloggs (KLG:NYSE) spun out its Pringles and Pop-Tarts snacks business into a new company called Kellanova (K:NYSE).

US industrial giant GE (GE:NYSE) has carried out two spin-offs. In 2023 it distributed a pro-rata dividend which entitled holders of GE common stock to receive a distribution of one share in GE HealthCare (GEHC:NASDAQ) for every three shares of GE held.

Earlier this month, GE distributed another pro-rata dividend which entitled holders of GE common stock to receive a distribution of one share in GE Vernova (GEV:NYSE) for every four shares of GE held.

Following these spin-offs, GE operates as GE Aerospace, a global provider of aircraft engines, systems and services with revenues exceeding $30 billion, but it retains its original ticker.

In the UK, industrial group Melrose (MRO) carried out a similar exercise in 2023, spinning off its automotive components business Dowlais (DLS) as a separate entity allowing it to concentrate on aerospace activities. 

DO SPIN-OFFS MAKE MONEY FOR INVESTORS?

Often spin-offs perform poorly shortly after listing as investors receive relatively few shares, meaning they have to buy more to build up a meaningful holding. Lack of broker coverage and familiarity with the business mean they are more likely to sell the ‘free’ shares and move on.

Hedge fund investor and author Joel Greenblatt believes these dynamics can present profitable opportunities to buy underappreciated and undervalued assets on the cheap.

One of Greenblatt’s biggest successes, as discussed in his book You can be a Stock Market Genius, was investing in the spin-off of property company Marriott International (MAR:NYSE) in the early 1990s.

Marriott’s board decided to de-merge the asset-heavy property business from the capital-light property management operation, and after poring over the 400-odd page prospectus Greenblatt spotted something interesting.

The debts of the company backing its properties were held by a subsidiary of the parent company which itself was debt free.

Greenblatt estimated the assets were worth $6 per share compared with the $4 per share asking price, meaning the company was selling for less than its tangible worth: four months later the shares were trading at $12.

However, not all spin-offs make great investments. A Harvard Business Review study analysed 350 public spin-offs valued at more than $1 billion between 2000 and 2020.

The results were surprising ─ the study found half of the companies failed to create any shareholder value within two years of separation while 25% destroyed a ‘significant’ amount of shareholder value. The average separation delivered just a 5% increase in combined market cap.

The contrast between the best and worst performers was stark. Top-quartile demerger performed very well with their combined market cap up 75% two years after separation, whereas companies in the bottom quartile destroyed value by as much as 50% of the combined market cap.

The authors of the study believe the key to success is creating a clear focus on the ‘go-forward’ equity story and targeting achievable financial targets before separation is even announced. This helps cement a clear roadmap for creating shareholder value.

In conclusion, spin-offs can be a profitable hunting ground, but good judgment and fundamental research is needed to find the few that go on to create sustainable shareholder value.

In other words, just because a demerged company is initially unloved or ignored by investors is no guarantee of future success. 

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