Last Updated on Jan 24, 2022 by Aradhana Gotur
This article is authored by Dayanand Deshpande, an MBA (Finance) from SJMSOM, IIT Bombay. Dayanand Deshpande has experience of more than 20 yrs in the stock market and is considered an authority on Special Situation value investing in India with a primary focus on spin-off investing.
I got introduced to this term after reading the Book, “You Can Be a Stock Market Genius” written by Joel Greenblatt.
Don’t go by the rather cheesy heading of the book. This book systematically explains what, why, and how of spin-off investing with one case study after another. I cannot recommend this book enough for any serious aspirant.
Before we talk about what is spin-off investing, let me bring home the point about its importance by quoting none other than Charlie Munger.
Mohinsh Pabrai asked Munger, how to make money in stock markets and Munger replied, concentrate on hannibals** and spin-offs.
**Self-cannibalism companies eating themselves up via buyback.
Table of Contents
What is a spin-off?
It is the process of breaking a company into two or more entities. After this process, each subsidiary becomes an independent company. The parent company issues shares to its existing shareholders of spun-off subsidiaries in a predetermined ratio.
On the ex-date, the parent company starts trading at price minus the subsidiary and that subsidiary gets listed on bourses at a later date.
Why do companies do it?
Corporate restructuring can be done for many reasons, however primarily, companies indulge in this endeavour because it is tax-efficient and helps in value unlocking of the cash-cow businesses.
Why does it work?
Forced selling: A lot of times due to regulatory mandates (size or change of industry), institutions are forced to liquidate their holdings in the new spun-off small company. This sudden and forceful selling creates a big dent and a lot of times stock goes way below its intrinsic value-creating opportunities.
Focus: Earlier with a conglomerate structure, employees’ attention and bandwidth were choked and spread too thin making them a jack of all. But with spin-offs, entire attention can be devoted to a niche business, which improves its efficiency.
Incentive: A lot of times new spin-off comes with employee stock options directly linked with the stock’s performance. The CEO finds a monetary reason to do well.
Pure play multiple: The stock market is known to value conglomerates at a discount and niche businesses at a premium. A great subsidiary business with an amazing cash flow gets a bad valuation because it is clubbed with lousy businesses. Value unlocking happens when a cash cow is freed from the shackles of dragging pigs.
Corporate debt structure: A lot of times, at the time of the spin-off, companies transfer the debt burden onto one entity, freeing the other from the interest burden creating a brand new future cash flow paradigm.
Historically, a lot of wealth has been created by spin-offs. A few that are eye-popping and are visible for all to see have been:
- Reliance and its subsidiaries
- Bajaj Auto demerging Bajaj Finance and Bajaj Finserv
- Adani Group demerging some multibaggers
Some of the demergers that we at Mystic Wealth have personally benefited from include:
- Alembic Pharma
- Kaya from Dabur
- Majesco from Mastek
- Intellect Design from Polaris
- Orient Paper
- Cement and electric CG Power
Those of you who wish to go in-depth should listen to a 1-hour webinar we did explaining the nuance around spin-off investing along with detailed backtests.
Our conclusions after spending a good decade searching and sniffing opportunities in the spin-off world are:
- Do your homework, pick your spots, not all demergers are the same
- A spin-off in itself, even without stock picking beats the index by a big margin
- Promoter buying adds extra is a confirmation to an already strong case
We practice this spin-off investing at our smallcase MWV (Mystic Wealth Value)The author can be reached at info@mysticwealth.in.
