A Positive Spin on Spinoffs

After Agilent Technologies spun off its semiconductor business last year, shares in the new firm, Verigy, soared. The stock is up 55% since the spinoff, versus 9% for Standard & Poor's 500-stock index. Another spinoff, Sally Beauty Holdings, is up 20% since Alberto-Culver set it free, compared with 7% for the S&P 500. This spring, Altria Group split off Kraft Foods amid much fanfare but decidedly mixed reviews. Even so, Kraft has been neck-and-neck with the S&P.

Detect a pattern? It's no fluke -- studies have shown that spinoffs are very good investments. Lehman Brothers found that spinoffs beat the S&P 500 by an average of 18 percentage points in their first two years as independent companies. A few theories explain the success. Managers of the new company are often motivated by incentives tied directly to its performance, in a way that was impossible in a bigger company. Also, the new stock often trades at a discount early on because investors who never meant to own it sell their shares, and eager buyers don't arrive until there's analyst coverage and a track record. Finally, the market often assigns a higher value to easy-to-understand companies.

Spinoffs can take a couple of different paths. The parent company may distribute shares as a dividend, in most cases tax-free for both the company and the investors. Or a company may sell stock in the subsidiary via an initial public offering. (By the way, parent companies also tend to beat the market in the months immediately before and after a spinoff. Watch Halliburton [symbol HAL] now that it has shed its KBR unit, a politically charged defense contractor.)

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

The easiest way to invest in spinoffs is through a new exchange-traded fund, Claymore/Clear Spin-Off (CSD), up 17% since its launch last December. The fund holds about 40 stocks. To employ a more targeted approach takes homework, such as scouring the Securities and Exchange Commission's electronic database (for help, check out www.gemfinder.com). For $69 a month, you can subscribe to Spinoff & Reorg Profiles (www.spinoffprofiles.com).

Spinoff editor William Mitchell says stock in Idearc (IAR), the telephone-directory business that Verizon spun off last fall at $26.25 a share, is still a bargain at $36. Spin-Off Advisors, a Chicago research firm for professional investors, thinks Metavante, a payment processor for financial firms, will be a good value when bank Marshall & Ilsley (MI, $49) spins it off later this year. Better yet, buy the bank now and get both.