One of the most eye-opening lessons I learned as an investor was that the biggest opportunities often lie where others aren't looking. Everyone wanted to know about the next big IPO or the hottest stock in tech. I discovered the value of spinoffs—a lesser-known strategy that has the potential to generate significant returns. These quieter, often overlooked corporate moves turned out to be hidden gold mines, full of value that many investors simply weren't paying attention to. Today, I want to share why companies set their divisions free, and why this often creates an opportunity for investors like us.
What Exactly Is a Spinoff?
A spinoff is essentially when a parent company takes a division or subsidiary and turns it into an independent, publicly traded company. Shareholders of the parent company often receive shares of this new entity as part of the process. The big question is: why do companies do this? After all, you might think they'd want to keep all the pieces of their business intact.
The answer lies in the idea of unlocking hidden value. Spinoffs allow both the parent company and the newly independent entity to focus on their core competencies. Instead of being weighed down by the different priorities and strategies of a conglomerate, each business can flourish independently. It’s like a child moving out of their parents' home—they gain the freedom to make their own choices and find their own success.
Why Spinoffs Can Be Lucrative for Investors
When companies announce spinoffs, many investors react with uncertainty. They don't fully understand the new structure, and they often sell off the shares they receive without digging deeper into the potential value of the spun-off business. This creates opportunities for savvy investors who are willing to do the homework.
I remember looking at the spinoff of PayPal from eBay in 2015. At the time, there was a lot of skepticism about how PayPal would do on its own. eBay shareholders received PayPal shares, and many of them offloaded these shares quickly. But I saw it differently—PayPal was a growing leader in the digital payments space, and by becoming independent, it could pursue new partnerships and growth opportunities without being tied to eBay's strategy. Since the spinoff, PayPal's market cap has grown significantly, making it one of the leading players in fintech.
Another more recent example is IBM's spinoff of Kyndryl in 2021. IBM had long been trying to modernize and focus on cloud computing and artificial intelligence, but its legacy IT services business was holding it back. By spinning off Kyndryl, IBM was able to sharpen its focus, and Kyndryl, as a separate company, could concentrate on growing its own IT infrastructure services without competing with IBM's core strategy. Initially, there was a lot of uncertainty, and the stock price of Kyndryl was under pressure due to widespread selling. But that very uncertainty is what creates an opportunity. When I looked at Kyndryl's fundamentals, I saw a company with solid cash flow and strong customer relationships, ripe for a rebound as it adjusted to independence.
Focused Management and Incentives
One of the key reasons spinoffs can be so successful is because management becomes highly focused on a single business objective. Instead of a larger conglomerate trying to juggle different divisions, both the parent company and the spun-off entity have their own goals and leadership teams who are deeply invested in their success. Many times, the management of a spun-off company is given significant equity in the new business, aligning their incentives with those of shareholders.
Think of it like this: when PayPal was part of eBay, its growth was tied to how well it fit into eBay's overall business. Once PayPal was independent, its leadership had a clear mission—expand digital payments globally. And the result speaks for itself. Freed from the parent company's constraints, spun-off businesses often become more agile, innovative, and ultimately more valuable.
The Power of Indiscriminate Selling
A huge part of the opportunity with spinoffs lies in what I call indiscriminate selling. When institutional investors, like mutual funds and pension funds, receive shares of a spun-off company, they may be forced to sell them because they don't fit their portfolio criteria. For example, they may only hold large-cap stocks, and if the spinoff is classified as a small or mid-cap company, they need to sell regardless of the business's potential. This creates temporary price drops that are often not based on the fundamentals of the company.
For instance, during the spinoff of Dow Inc. from DowDuPont in 2019, many institutional investors sold Dow Inc. shares simply because it no longer fit their investment mandates. Dow Inc. was undervalued immediately after the spinoff, despite being a profitable, well-established business. Investors who recognized this were able to buy in at a discount, and the stock appreciated significantly as the market began to see its true value.
Practical Takeaways for Investors
Do Your Homework: Spinoffs are often misunderstood and therefore mispriced. By digging into the fundamentals of the spun-off company, you can find opportunities others are missing.
Look for Management Alignment: When management of the new entity has significant skin in the game, they are more motivated to drive the business forward. This alignment with shareholders is key to long-term success.
Take Advantage of Indiscriminate Selling: Watch for the initial period after a spinoff when institutional investors might be selling without regard to the spun-off company's value. This can be your chance to enter at a favorable price.
Conclusion
Spinoffs are a fascinating corner of the market that can create significant opportunities for investors willing to do the work. By understanding why companies set divisions free and recognizing the dynamics of focused management and market inefficiencies, you can uncover hidden value where others see only uncertainty. In my experience, the key is to look beyond the initial noise, dig into the business fundamentals, and understand the motivations behind the spinoff. This is where real, long-term value can be found—often in the places where the rest of the market isn't paying attention.